Good morning, ladies and gentlemen, and welcome to the NAPCO Security Technologies Fiscal Second Quarter of 2024 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Monday, February 5, 2024. I would now like to turn the conference over to Francis Okoniewski, Vice President, Investor Relations. Please go ahead.

Thank you, Jillie, and good morning, everyone. My name is Fran Okoniewski, Vice President, Investor Relations for NAPCO Security Technologies. I just want to thank you all for joining us today on our conference call to discuss our financial results for our fiscal second quarter 2024. By now, all of you should have had the opportunity to review our earnings press release discussing the results of our quarter. If not, a copy of the release is available in the Investor Relations section of our website, www.napcosecurity.com. On the call today are Richard Soloway, our President and Chief Executive Officer of NAPCO Security Technologies, and Kevin Buchel, our Executive Vice President and CFO. Before we begin, let me take a moment to read the forward-looking statements as 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, 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 software-as-a-service 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 for 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 provided in today's press release and this conference call is as of today's date, unless otherwise stated, and we undertake no duty to update such information except as required under applicable law. I will turn the call over to Dick in a moment, but before I do, I want to mention we are actively planning our Investor Relations Calendar for more non-deal road shows and conferences in the near future as investor outreach is very important to NAPCO, and I would like to thank all those folks that assist us in these conferences and non-deal road shows. Also, we invite you to come and visit our booth at the upcoming ISC West Trade Show, April 9th through the 11th in Las Vegas. ISC West is the industry's largest trade show with over 30,000 attendees. So, if anyone is interested in attending, please contact me and I will arrange to get you a pass. 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, Fran. Good morning, everyone, and welcome to our conference call. Thank you for joining us today to discuss our results. We are pleased to report our fiscal Q2 2024 record sales of $47.5 million. This is the 13th consecutive quarter we've achieved record sales for the quarterly period. Recurring revenue subscription service continues to grow at a very strong rate and the annual prospective run rate is now $76.5 million based on January 2024 recurring revenues. Our balance sheet remains strong with our cash balances at $79 million, an 18% increase over the June 30, 2023 level. We have no debt. We continue to focus on capitalizing on key industry trends, which include wireless fire and intrusion alarms and the related recurring service revenues, 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, and returns on equity, as well as controlling our costs. 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 of NAPCO owns approximately 10% 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 second quarter results, and then, I will be back with more on our strategies and view of our markets. Kevin, the floor is yours.

Thank you, Dick. Good morning, everyone. Net sales for the quarter increased 12% to $47.5 million, and that's the highest quarterly sales in the company's history. And that compares to $42.3 million for the same period one year ago. Net sales for the six months ended December 31, 2023 increased 9% to a six-month record of $89.2 million, and that compares to $81.8 million for the same period one year ago. Recurring monthly service revenue continued its strong growth, increasing 25% in Q2 to $18.5 million as compared to $14.9 million for the same period last year. Recurring monthly service revenue for the six months ended December 31, 2023 increased 25% to $35.8 million as compared to $28.7 million last year. Recurring service revenues now have a prospective annual run rate of approximately $76.5 million based on January 2024 recurring revenues, and that compares to $72.5 million based on October 2023 recurring service revenues, which we reported back in November. Equipment sales for the quarter increased 6% to $29 million as compared to $27.4 million last year. This increase was due primarily to revenue increases in both Alarm Lock and Marks brand door-locking products, as well as increased sales of NAPCO brand intrusion products. Of note is that the StarLink radios sales in Q2 sequentially increased over those sales in Q1 by 63%. Equipment sales for the six months increased 1% to $53.4 million as compared to $53.1 million for the same period last year. This increase was primarily due to increases in both Alarm Lock and Marks locking sales as -- offset by a decrease in NAPCO intrusion sales due to the previously discussed decline in StarLink radios. Gross profit for the three months ended December 31, 2023 increased 74% to $25 million with a gross margin of 53%…

Thank you, Kevin. The first half of fiscal 2024 is off to a great start with fiscal Q1 and fiscal Q2 results, achieving record sales and profits, driven by hardware-enabled recurring revenue growth of 25% and which represents approximately 40% of total company revenues. Our net income of $12.6 million and adjusted EBITDA of $15.1 million were quarterly record breakers. Equipment revenue improved, growing 6% for the quarter, with gross margins on such sales sequentially increasing to 29% from 28% last quarter. Radio sales in Q2 improved over Q1, increasing by approximately 63%. While such sales were still 13% below the radio sales of Q2 last year, when the impending 3G Verizon sunset was rapidly approaching, the increase over last quarter was significant. We expect radio sales to continue to be a key contributor to our hardware sales and continue to lead to the continued growth of our highly profitable recurring revenues. Gross margin for recurring service revenues was once again strong at 90%. And when combined with gross margin on equipment revenues of 29%, the total gross margin for Q2 amounted to 53%, which compares to 34% for last year's Q2. We are particularly pleased to see the growth in equipment revenues, which was primarily attributable to the continued strength of locking revenue in addition to the improvement in intrusion sales. We also saw -- we also are pleased with the increase in the recurring revenue's annual run rate, which increased to $76.5 million based on January 2024 recurring revenues, compared to an annual run rate of $72.5 million based on October 2023 recurring revenues. Our Alarm Lock and Marks locking hardware lines continue to see growth in school and classroom security, healthcare, and retail loss prevention, as well as multi-dwelling commercial and residential applications, growing approximately 10% compared…

Thank you. [Operator Instructions] Your first question comes from Chad Bennett from Craig-Hallum. Please go ahead.

Great, thanks. Great job guys on the quarter. Great to see the rebound in the equipment business. So, I guess maybe first question is, I know you touched on it in the formal remarks, just on the radio inventory issue. It seems like it's largely behind us and probably even faster than maybe we thought. Just trying to get an idea, do we still expect some headwind in the March quarter or potentially even in the June quarter from that inventory issue, or how should we think about that?

I think, Chad, that we thought it was going to take a couple of quarters to get it behind us. We thought that this quarter would be affected similarly as it was in Q1. We saw a lot of progress in Q2, and hence you saw the big increase in radio sales in this quarter versus last. We're not done yet. We're not 100% there. We still have some work to do. I think at the end of Q3, it'll be all behind us, but the fact of what's occurred in Q2, there's a lot to getting this issue behind us. And we're going to continue to work hard to make sure there's no issue left by the end of Q3.

Right, got it. And then, just shift into the locking side of the business, I think you talked about locking growth of roughly 10% year-over-year. Just in terms of kind of sell-through there and demand there, were there any changes in demand in that business? And then, I think you highlighted the verticals that you're seeing strength in. Should we think about that business differently from a growth rate relative to what you did this quarter, or was this quarter kind of an anomaly there?

Locking has done well for several quarters in a row, maybe last, even, couple of years in a row. So, nothing unusual that gave us the strength. What's great is we have two locking companies. We have Alarm Lock and we have Marks, and both of them are firing on all cylinders. And that's why we're seeing the success in locking. So, we expect that to continue for many quarters to come.

Got it. And then, maybe last one for me. EBITDA margins look phenomenal, continue to improve in the low-30%s, I think, again, at least ahead of what I was thinking. I know we had some finance and accounting costs that rolled in this quarter, potentially maybe incrementally more rolling in in the next quarter, but it seems to me like EBITDA margins are likely going from the low-30%s to the mid-30%s in a short period of time. Is that a fair assessment, Kevin?

Yeah, well, we're at 32%. We're well on our way to the 45%. It's going to take more time. We won't get to the 45% obviously by the end of this fiscal year. But when you have 40% of your revenue generating 90% gross margins, which is what we have, the recurring now being roughly 40% of total revenues, that takes you a long way to getting to where we want to go. And we're going to keep adding, obviously, to that recurring. And we think the margins will get better on the hardware as we progress through the rest of the fiscal year. Between those two events, there's no reason why we shouldn't see the EBITDA margin go even higher in this fiscal year.

Got it. Thanks. Nice job on the quarter.

Thanks, Chad.

Thank you.

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

Hey, guys. Thanks for taking my questions. Kevin, just curious if you could share with us some of the sell-through metrics you saw your distributors in the December quarter.

We saw, on the intrusion size, a big improvement from the two distributors who we've been referring to as being the ones that had the excess radio inventory. So that was -- we expected that to occur. It occurred faster than we thought. One in particular, they just did a phenomenal job working their way through. So, their sell-through stats were great. And the sell-through stats for most of the intrusion is much better than it's been. Not back to where it was. No, we're not 100% to where we were, say, a year ago, but we are much better than where we were a quarter ago. And we expect that to continue as we continue to help our distributors promote products, help them move radios. We're coming out with additional radios that are going to give us recurring. So, we're doing a lot of things that are going to help the sell-through. And the sell-through stats with locking continue to do well. We watch all these stats every week, every month. We watch the inventory levels for all of our distributors. We're pretty pleased the way things have been going right now.

We want you to understand that our radios, which generates the recurring subscription revenue, has tremendous opportunities because you have millions of commercial buildings that are still operating on the old legacy copper. And our radios are the best choice for the dealers. They have a lot of features that the dealers like. So, it's really supercharging the Fire radios. Additionally, there's many, many small business residential jobs that need our radios also. So, we make a line of those radios. Millions and millions of jobs are out there that are operating on copper that have to be converted over over the next few years. And then, you have all of our products with the radios built in. The Fire panels, it's built in. The new Prima, it's built in. And those jobs are for new work. So, there's a lot of opportunities for us. And it's a very, very exciting future. And you can feel what's going on by taking a look at our numbers. And we expect this to continue to our 2026 goal of $150 million recurring. So that's the future for us.

Okay, that's really helpful. And I know you mentioned that you think the radio inventory issue will be behind you after Q3, but just curious if your own higher cost inventory should largely be chewed through by then as well.

Yes. The higher cost should be behind us. Besides working on inventory at distributors, we're working on getting the inventory that we possess, getting through that as well. And so, if it's not gone by Q3, I think most of it will be, maybe there'll be some in Q4. But most of our inventory now is more normally costed. Days of the crazy high costs caused by the supply chain are mostly behind us.

Got you. That's it for me. Thanks a lot, guys.

Thanks, Jaeson.

Thank you.

Your next question comes from Jim Ricchiuti from Needham & Co. Please go ahead.

Hi. Thank you. Question, I wanted to go back again to the sequential growth in radios, and admittedly, this is somewhat of an easy comparison, but to what extent are you seeing any benefit on the radio side from the addition of the new distributor, or is it also just in combination with the improved sell-through in general?

It's both, Jim. So, adding the new distributor certainly helped. But it's not like we loaded up this new distributor and it gave us a one-time hit improvement to radio sales. We didn't do that. We sold this new distributor normal amounts, enough inventory where somebody goes into their distribution center and they have the inventory, not too little, not too much. It's a contributor. But besides that part, the contribution we saw was helping the other distributors move through their inventory. And they move it through, and it creates new demand with the dealers. That's what this is all about. These distributors are just shelves. The bottom line is we have to create demand at the dealer level. Having the new distributor with 115 new branches certainly helps, but also pushing a lot of this inventory through to dealers at all the branches of all the distributors is the biggest factor. And we expect demand to be strong going forward.

Hey, Kevin, on the -- I'm sorry, Dick. Go ahead.

There's going to be 30,000 security installation dealers visiting us in Las Vegas, which is the biggest show. And Fran can set people up to come and see the dealers as they come by our booth. It's going to be upfront, it's going to have the widest range of radios, the entire industry right there, all of our new products will be right there. So, we're going to get a lot of leads. And as I said, there's millions of jobs that have to be upgraded from legacy copper. There are huge numbers of jobs of new work that have to be installed. When you're putting up a building, you must have a fire alarm, burglar alarm today, residential alarms, because of what's going on in society. So, we're going to get a lot of dealers, a lot of new leads, and we have a great sales group of guys that are going to follow up on those leads. So, we expect to get even more pull-through between our existing distributor base that we have, plus our new distributor, which is the largest in the security industry, that will generate additional continuous growth of radio sales.

Hey, Dick, what kind of traction are you seeing from Prima? I know it's early days yet, but what's the initial read on how the product is doing?

I think that the product has tremendous legs to it. The product is beyond anything else in the security industry with its functionality, ease of installation, goes in in 10 minutes. With what's going on in society, you need an alarm system for your business and you need an alarm system for your home. And the Prima was designed so that the actual salesman that sells the job to the end user customer can install it in less than 15 minutes, very, very quick, or we can leave it behind for the consumer to DIY it if he wants to do that. So I think the opportunities are tremendous. As we said, it takes a year or so for a new product. And this was only developed -- it was only sent to the market a few months ago to become a success. So, we expect that considering the fact that alarms are being put in, and they're a little old fashioned that the competitors have, and this is very, very modern and installed so quickly, this will become a standard of the security industry. And every alarm that goes in that's Prima has a recurring revenue tail to it, so it's going to generate a lot more recurring revenue. Part of our 2026 goal didn't even include it. It was just the existing products. But this will add more to the whole mix of what we're doing.

Got it. Final question for me. Kevin, just looking at the expense side, how much of the higher costs for the stepped-up financial controls were in the quarter, or is this going to be more fully reflected in the March quarter? And lastly, just on tax rate, should we assume the similar tax rate?

So, on the first part of your question, Jim, some of the additional costs went into the SG&A in this quarter. We started with Deloitte. Deloitte is now our auditors. So, obviously, that extra cost has started. We've only done one quarter with them, Q2. We have our consulting firm, so that's filtered into the numbers. What you haven't seen yet are the additional employees, the internal auditor, and the additional cost accountants. We're in the process of doing those hires. I expect that will start in Q3, quarter that we're in now. So, we'll see that going forward. And those are recurring expenses, additional employees, as is the Deloitte piece, the consulting [Technical Difficulty]. Our tax rate has been 13%. Every quarter, full year, when I model, I use 15%, but we've been running at 13%. So, unless the laws change, I continue to use 15% for modeling.

Okay. Thank you.

Thanks, Jim.

Your next question comes from Matt Pfau from William Blair. Please go ahead.

Hey, great. Thanks for taking my questions, and nice quarter, guys. I wanted to first ask on the new distributor that you added. Sounds like there was some impact there to hardware in the second quarter. How should we think about that going forward? Is there going to be an inflection or is this more of a slow ramp?

Yeah. Our distributor has been around a long time, this new distributor, with the 115 branches. We dealt with them in the past. They're new to us now. This wasn't a case of loading up, load up all 115 branches, get a big hit, and then things slow down. This is a more normalized ramp up. Whatever impact they had in Qs one and two, we expect it to improve dramatically. They're the biggest security distributor out there. And we've only been dealing with them for a little bit of Q1 and all of Q2. So, the potential is much more than what we've seen. Again, we didn't load them up. It's natural business, which is the way we want it. We don't want to get in a situation where we load them up and then they want to return it and it's not like that. We want sales that'll stick, and that's how it's going to be with these guys.

Got it. I know it's early, but are you seeing new installers start to use NAPCO products? And are you getting inbounds or developing relationships with new installers as a result of the new distributor agreement?

We're seeing new larger customers due to this arrangement, because certain large customers use this distributor as their main distributor. So, with introductions and the fact that the products are superior to what's on the marketplace is great for us. These new customers have said, "Wow, I didn't realize the functionality we get and the ease of installation we get for our crews that are out in the field." And once they see this, they become adopters of the product. So, it's a great relationship because there are certain dealers that want to use this particular distributor that only uses distributor. So, that opens those doors in a big way.

Great. Thanks for taking my questions, guys. Appreciate it.

Thanks, Matt.

[Operator Instructions] Your next question comes from Raj Sharma from B. Riley. Please go ahead.

Yeah, thank you. Congratulations on the nice quarter, guys. My question is on the growth rate for the next few quarters or the next few years. Alarm and intrusion this quarter is about flat and locking was up 10%. Should we expect -- what kind of growth rate should we expect for the next few quarters? In-line or ramping up?

Alarm was actually up this quarter. It wasn't flat, it was up by about 5%, actually. So, we expect all in, we want to be 10% or greater. And this 6% that we were up for this quarter was very encouraging as we get back to a 10% or greater growth rate for hardware. In order to do that, we need all the players to be a part of it. That means the intrusion side, the locking, and the access. The locking has been doing great, two companies, Alarm Lock and Marks, both firing on all cylinders. NAPCO was hurt by the radio decline, came back up 5% this quarter. We expect more, more because of Prima, more because of the new distributor, and more because radio sales will come back. So, as we go forward, 10% or greater is what we're looking for.

Great. And the locking is the similar sort of a growth rate or higher?

Locking has been higher, being conservative, modestly, 10%. But they can do a lot more and have been.

Right. And next question is recurring revenues. The retention rates must be pretty high. Is there any sort of number on the retention rate or the number of devices that are live?

The retention rate is very high. Churn is a big word that's used when you're in the residential space. We're mostly commercial. Churn is insignificant. Now, when we have Prima being a bigger part of our sales, there may be a churn rate. It's residential. Residential people change their minds. They decide they want a system, then they don't. We'll look at that when we get to that point. But for right now, where we are, churn is inconsequential. And there's roughly 750,000 radios that are generating the run rate of $76.5 million. So, to get to our $150 million goal by 2026, the way we look at it, essentially, we got to add another 750,000 radios. And that's not a lot when you consider the millions and millions of opportunities that are out there. We're not saying we have to get every one of them. We'd love it. We've got to get our fair share. 750,000 out of the millions is not even a high percentage. So that's what gives us confidence about hitting the goal.

Got it. And the growth in the recurring revenues, which products are contributing the most, which are contributing the least? Any sort of color on that?

The Fire radios are the biggest contributor. That's why you're seeing the gross margin of 90%. Fire radios gets the most on a monthly basis compared to the others. The others are great, too. Fire leads to 90%. The others, maybe they lead to 80%, 82%, 83%. Not so bad. All good. But Fire is number one.

Got it. And then, the sell-through -- last question for me. Sell-through at dealers, you said, is picking up. And I know because of the excess inventory issue for a couple of dealers, it was lagging the year-on-year. Overall, is it up 5% sell-through you think at dealers or up 10% now?

I'd have to look at that, Raj. What I do know is it was much more in Q2 than Q1, but I'll have to look to see where are we year to date. Probably up, given what I saw in Q2.

Overall, it's up faster than what your quarterly year-on-year is exhibiting. Would that be fair to say?

I think it's fair to say that it's up compared to what we expected. It's happening faster. And on locking, it's very good. And on intrusion, definitely up sequentially. Versus a year ago, I'd have to look.

Got it. That's it for me. Thank you for answering my questions again.

Thank you, Raj.

Congratulations on a good quarter. Thanks.

And there are no further questions at this time. I will turn the call back over to the CEO, Richard Soloway, 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 Fran, 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 Q3 results. Have a great day, everybody. Bye-bye.

Ladies and gentlemen, this concludes your conference call for today. We thank you for joining, and you may now disconnect your lines. Thank you.