Greetings and welcome to the NAPCO Security Technologies fiscal fourth quarter 2018 and year-ending 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] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Patrick McKillop, Director of Investor Relations. Please go ahead.

Thank you and good morning. My name is Patrick McKillop. I'm the Director of Investor Relations for NAPCO Security. Thanks for joining us on today's call to discuss our financial results for our fiscal fourth quarter 2018 and fiscal year 2018. By now, all of you should have had the opportunity to review the press release discussing the results. If you have not, a copy of the release is available in the Investors Relations section of our website, www.napcosecurity.com. On the call today is Richard Soloway, President and CEO of NAPCO Security Technologies, and Kevin Buchel, Senior Vice President and CFO. Before we begin, let me take a moment to read the forward-looking statement. This conference call may contain forward-looking statements that involve numerous risks and uncertainties. Actual results, performance or achievements may differ materially from those anticipated in such forward-looking statements as a result of certain factors, including those set forth in the company's filings with the SEC. During the call, we may also present certain non-GAAP financial measures such as adjusted EBITDA and certain ratios that are used with these measures. In the press release and on the financial tables issued earlier today, you'll find a definition of these non-GAAP financial measures, a reconciliation of these non-GAAP financial measures with the closest GAAP financial measure, as well as a discussion about why we think these non-GAAP financial matters 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 before I do, but I just wanted to mention a few things on the IR front. In terms of upcoming investor outreach, we will be presenting and hosting one-on-one meetings at the CL King conference in New York on September 13. Investor outreach is crucial to small cap companies such as NAPCO, and I would like to thank all of those folks that assist us in these conferences and marketing trips. With that out of the way, let me turn the call over to Richard Soloway, President and CEO of NAPCO Security Technologies. Dick, the floor is yours.

Thank you, Patrick. Good morning, everyone, and welcome to our conference call. Thank you for joining us today to discuss our results. The fourth quarter and fiscal year 2018 marked another record revenue and profitability performance for NAPCO. Our SaaS recurring revenues continued to grow at a rapid rate. Our recurring revenues annual run rate is now $14.7 million as of July. The driver of the growth for recurring revenue continues to be all of our StarLink offerings, which include intrusion, fire and connect. In the fourth quarter and fiscal year, we maintained the level of investments in R&D and selling and marketing expenses versus the year-ago period. It is our belief that we have the appropriate levels of investment for R&D and SG&A currently. Our net income increased by 37% this year, thus showing returns on the investments we have made. Our balance sheet remains strong with zero debt as of this report and our cash balances continue to grow. We remain focused on capitalizing on key industry trends. These trends include smart connected home, recurring revenue growth in cellular alarm communicators, and the creation of school security and safety products. All these trends are having a positive impact on our results. The key metrics of growth, profits and returns on equity are equally important to both shareholders and the management team here at NAPCO. Our business strategies are executing well and our interests are aligned with our shareholders and senior management at NAPCO owns 38% of the equity. Before going into greater detail, I will now turn the call over to our CFO, Kevin Buchel, who will provide an overview of the fiscal fourth quarter and fiscal year 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 fourth quarter, net sales increased 6% to $27.3 million, which was a record fourth quarter performance. For fiscal 2018, net sales increased 5% to a record $91.7 million. The increase in sales for the quarter were primarily related to the increased sales of our alarm communications products and services, access control products, and door locking products. For the full fiscal year, the increase in sales was primarily related to increased sales from alarm communications services as well as access control products. Recurring monthly revenue from the alarm division increased 49% for the quarter and 51% for the fiscal year. Recurring revenue now has an annual run rate of $14.2 million based on June 2018 and $14.7 million based on July 2018. Gross profit for the fourth quarter increased 4% to $12.1 million, with a gross margin of 45% as compared to $11.6 million with a gross margin of 45% last year. Gross profit for the fiscal year 2018 increased 5% to $38 million, with a gross margin of 41% as compared to $36.3 million with a gross margin of 42% last year. I’d like to remind you that research and development expenses are now shown separately as part of our operating expenses and are no longer included in cost of goods sold. We believe this is a clearer presentation and we have made this reclassification for all prior periods as well. As Dick mentioned, our R&D and SG&A expenses for the year were relatively constant versus the year-ago period. R&D expenses for the fourth quarter decreased 4% to $1.7 million or 6% of sales compared to $1.8 million or 7% of sales last year. For the fiscal year, R&D expenses were relatively constant at $6.7 million or 7% of sales as…

Kevin, thank you. Our business has to paradigm shifts that we have continually highlighted to investors – school security and SaaS recurring revenue. We are experiencing growth in both of these areas and we expect that trend to continue in the future. During the earlier portion of this call in which we discussed our financial results, the strong growth of our SaaS recurring revenue was highlighted. Demand for recurring revenue products is coming from alarm communicators, the smart home category and the continued expansion of the Internet of Things theme. We continue to believe the school security market remains a significant opportunity for us. The total addressable market for school security is very large, with over 100,000 K-12 schools and over 10,000 colleges and universities in the USA. The vast majority of these schools have no physical security in place to protect them from violent incidences that continue to happen on a regular basis. It is our belief that the amount of spending on school security and safety products will begin to accelerate and continue at a strong rate for the foreseeable future. Also, the professional alarm monitoring market is expected to thrive during the next five years as connected systems supersede traditional alarm monitoring systems according to a recent IHS market report. Our strategy is focused on introducing new and innovative products and services that are compelling to the end-user as well as products and services that help our dealers to grow and succeed. We are proud that, earlier in the year, we were voted one of the best intrusion brands among industry titans such as Bosch and Honeywell according to Security Sales & Integration magazine, a top industry publication. NAPCO is positioned strongly to take part in the growth of the US alarm market, both with our legacy…

[Operator Instructions]. Our first question comes from Mike Walkley, Canaccord. Please proceed with your questions.

Thank you. And congratulations for delivering on a strong end-of-year fiscal quarter.

Thank you, Michael.

My first question, just given some of the growth drivers you outlined such as new high-rise construction and funding now at state levels going for school security, campus upgrade spending, can you just walk us through kind of your thought process on how you see hardware growth trends over the next 1 to 2 years for your business?

We have a number of new products addressing those markets, which typically there’s a gestation period for those. They're going to be school security products, which will enhance our existing line, and recurring revenue products. Both of those products should drive our product volume nicely. So, that's what we have on tape. As I said, we have 50 engineers. We’re very diligently working on these new solutions to create new verticals off of these segments of our business. So, you’re going to see them, as we said, this year, next year. It takes a little bit of time for them to be adopted by the trade, but early indications are we’re right on track.

Great. That’s helpful. And then, just in terms of the school opportunity, can you update on how you're winning business, how your sales coverage is in terms of all these states investing? Thank you.

We have our dealer network, which are thousands of dealers that are out there, and these dealers – we are very unique in the fact that these dealers, some of them are in the locking area and they work with the security department in the lock shops, as they call them, in the colleges and universities. And some of the dealers are into the alarm business. So, we cover both sides of the industry. We’re unique in that way. We’re the only company that has locking and alarms. Everybody else is either into locking or access or other companies only do alarms. We do both. So, our dealers are constantly dealing with the school administration and the school custodial department. And then, when the schools are ready to protect themselves and they're getting funds to do that, our people are there and they bring these leads into our sales groups, and our sales groups sit with the schools and show them how our solution is totally integrated. There’s been many jobs that we haven't published about that we've gotten, and more to come because we have a lot of bids that are out there. We only are allowed to release press releases when we get the approval of the school. A lot of them don't want to have their name associated because – for whatever reason, political purposes in the school. But we put out as many as we can and it gives you kind of a heartbeat of what's going on here at NAPCO. But we’re pounding the streets with our dealers on both sides, the locking side as well as the alarm and access side.

Great, thanks. Last question from me. I’ll pass the line. Maybe more on the model here. Just coming off your seasonally strong Q4, what’s the feedback maybe from your distribution channel on inventory and how we should think about seasonality into the September quarter? And then, also for the model, just how should we think about just the tax rate going forward, given it’s at a lower rate here the last couple of quarters? Thank you.

So, Mike, typically Q1 is not as high a number as Q4, but it's gotten much better over the last couple of years. So, a Q1, we expect it to still be in the 20s. And when we get in the 20, that becomes profit for us. And inventory is moving through the pipeline very nicely and we expect the Q1 to do really well. We don't expect it to beat – everybody is so loaded with inventory, they're not going to buy. There’s going to be a lot of action. We've seen it already in the early parts of this quarter that we’re in. So, we’re very encouraged that Q1 will be a good one, as well as the rest of the year. We've reached the point now where every quarter is a good one. And, of course, the recurring revenue helped, but it’s beyond that. And as far as the tax rate, we were helped this year by the new law and a few other factors that go into our tax calculation. But going forward, I would use 15% as the guiding rate. It might wind up being a little less, but that’s a fair rate. I don't think it will be more than that. We’re helped by a lot of factors. The new law helps us, but use 15%. Use 15%.

Great. Thank you very much.

Okay, Mike.

Our next question comes from Gary Mobley, The Benchmark Company. Please proceed with your question.

Good morning, guys. Thanks for taking my question. Dick, you mentioned in your prepared remarks a desire to bring down some of your cost of goods sold for your hardware products and sourcing them from alternatives to what you’ve done so far, specifically out of Asia. But I'm curious to know how the change in tariff – with increased tariffs imposed by the US, how this impacts your cost of goods sold and as well your ASP for those goods imported from the Dominican?

Tariffs probably are hurting a lot of companies, but not us because of our Dominican operation and because we ship directly to the Dominican Republic. That's where all the action is. That’s where all the manufacturing is. So, for us, no effect. What will make things better is increasing the number of parts that we’re going to buy direct from Asia. We buy from Asia now. It’s not like this is a new concept, but it is a concept of aggressively doing more from there. It’s the low cost area. We’re not going to get hurt by the tariffs. Why not go after it? It will affect the cost of goods sold. The COGS number will come down. And in a way, it's a recurring expense savings because, once you save it, you get it year after year. So, this is a big project that Dick is leading. We expect it to be very successful in fiscal 2019 and for years beyond.

Okay. And relating to that, your gross margin on your products dropped about 200 basis points in fiscal year 2018 and basically finished the year at sort of the same trend rate, dropping in Q4 about 200 basis points year-over-year. Is that a function of mix? Is it a function of rebates or any other factors you can mention?

Mostly, it’s mix. There’s nothing really that stood out that we could point to that changed things, but the mix – it’s very important what the mix is. And sometimes, it's a little higher. Sometimes, it’s a little lower. We’re encouraged that, for the year, overall, the margins were what we expect that to be, over 40%. And we were encouraged that, on the recurring revenue margin, that it was higher in the fourth quarter than it was in the prior quarter. We had mentioned that we expected a rebate from the carriers to come through in Q4. And it did. And that led to a 2% improvement on the margin for the recurring. So, net-net, the margins were pretty close to last year. With the project that Dick is undertaking, that’s going to make it even better. And, of course, as the volume ramps up, that helps too. So, we feel very good about the margins as we go forward.

Okay. Since there no mention, there was no share buyback in the quarter? Can you confirm whether or not the remaining amount under the existing share buyback program stands at about 230,000 shares?

Right. There was no buyback in Q4. It is about 230,000 and we opportunistically look for times when we will buy back. And just stay tuned because we could do more. The beautiful thing that's going on here, cash is growing, no debt. And the big problem here is a good one – what to do with that cash? It’s a great problem to have. And we’re now experiencing it because the cash is really starting to grow because the big sales from Q4 was starting to collect all that. And that means the cash balance that you see on the June statement will be more. It is more right now. And so, that’s a good problem to have.

Okay. All right. That’s it for me. Thanks, guys.

Thank you.

[Operator Instructions]. Our next question comes from Brian Bethrow with Deutsch Advisors [ph]. Please proceed with your question.

Good morning, guys. Your equipment growth this quarter was fairly minimal. Could you talk about what's growing and what shrank most recently?

The recurring revenue has grown very, very nicely and school security products have grown very, very nicely. And there’s some – I would say, less business in the alarm control panel business in the industry in general. But we expect that to pick up and we believe it’s a temporary aberration.

And remind me, on just the equipment side, not the recurring side, but is the school lock business, is that a higher margin business for you?

Yes, it is.

Okay. So, based on what you said earlier and based on everything you read in the news and a couple of announcements that you've made, I would expect – or, I guess, I would ask you, do you think that overall sales on the equipment side should accelerate here?

I believe it will. There's also bunch of new products on the equipment side, which we believe will add a lot of growth to the equipment and kind of change the equipment paradigm. And these products have been in the works for a couple of years. So, I would expect that, over the next six months, they’ll be out, which will generate lots of business for us, probably six months to a year out from that because it takes a little bit of time for the dealers to get used to them. And they're very interesting products and never been done before. So, it should be very exciting time for us, putting a lot of resources to getting these products out. That should bolster up the hardware very nicely.

Okay. And you have some exposure, just general lock type business. I would imagine, with the housing market softening up a bit, is that sort of reflected in that piece of the business just being a little soft?

Well, we don't supply any products residentially in the hardware side of the business.

But on the commercial side?

Only the commercial. So, our locking products are used in new high-rise buildings of all types and also in retrofits where they're renovating lots of offices. So, we do both of those areas. And then, of course, the school lockdown systems also where we talked about the budgets that are being expanded, people are waking up to the fact they better do something to protect those kids and the faculty and lots of bidding is going on.

Okay. Remind us, on the school alarms, is there a recurring component to any of that sales?

The recurring is not a monthly thing. The recurring comes from doing a portion of a school; doing, for instance, the dorm rooms, 1,000 dorm rooms, 500 dorm rooms; then doing, a few months later or six months later, the classroom; then doing other parts of the campuses. So, we see a lot of that. Like we talked about, the Pepperdine, I think it’s the fourth time now we’ve gotten orders for expanding the system. As they get used to it and use it and they can see the expansive capabilities and how well it works, we get additional orders. That’s the recurring.

And how would you classify that business when you're bidding on it? Would you say it’s highly competitive or are you often the only company in there making bids?

A lot of schools choose us because we’re the only ones that make the locking side and the access control side and it's all integrated here under our Fusion technology. And then, all the technical calls are handled here in Amityville. Other competitors, you have to call one company to get the locking answers and another company to get the access control answers, and it creates a lot of confusion. So, a lot of schools have said, gee, if you’re not an integrated solution manufacturers, don't bother to bid. And we win business that way also. So, there's a lot of different aspects of winning it. But being a one-stop shop manufacturer is unique in the industry and it gets us business.

I'm not sure what the school budget cycle is and where they run, but are they going right now to the extent of where these budgets are being approved with dollars that are earmarked towards your type of product? Or is that something that would happen in the early part of next calendar year?

I think it happens both, Brian. A lot of them are July 1, June 30 fiscal years, but not all of them. A lot of the schools want product when the kids are out of school. So, the bidding process was very, very high in the months that have occurred since the year end because they want to put product in before the kids come back. So, now, a lot of the kids are coming back and jobs are being awarded and the same thing will happen in December when the kids are out again. And if it's a university, the kids are out for a month. And so, you see a lot of action that time of year too. So, there's no magic that it’s one time of year. It’s throughout the year.

Okay. Last question I have is on acquisitions. I know you talked about this before. You haven't announced anything, which is fine. The last thing, I think, we’d want to see is you announce something that isn't a great fit, but has it been more you haven't found compelling businesses to buy or has it been more an issue of price?

It’s a combination of both. Since NAPCO is unique in the fact that we do have two locking companies, an access control company and alarm and connected home division, it's very hard for us to find companies that bring something new to the table. And the ones that are new to the table want high valuations because the security industry is that way. It’s very top-of-mind. It’s one of the most important things, is to protect life and property. So, they want high prices. So, between those two facets of things, it’s a problem. It’s not number one on the hit parade for us. We want to focus with our 50 engineers in getting out new products with recurring revenue. We want to protect the schools. So, we’re spending most of our time on that. And then, we do talk to people about acquisitions, but it’s not our main focus and drive. We can grow this business a lot. There’s a lot of room for growth by growing it internally. And if the right acquisition comes along with the right price and we’ve said if we can manufacture in the Dominican Republic, if our dealers use it with our systems to help build on, then we would entertain it.

That does it for me. Thank you.

Thank you.

[Operator Instructions]. Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to 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 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 Q1 2019 results. Bye-bye.

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