Greetings. And welcome to the NAPCO Security Technologies, Inc. Fiscal Second Quarter 2020 Earnings 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 will now turn the conference over to your host, Director of Investor Relations, Patrick McKillop. Mr. McKillop, you may begin.

Thank you, Daryl. Good morning. My name is Patrick McKillop. I am the Director of Investor Relations for NAPCO Security. Thank you for joining us for today’s conference call to discuss our financial results for our fiscal second quarter 2020.By now all of you should have had the opportunity to review the press release discussing the results. If you have not, a copy of the release is available in the Investor Relations section of our website www.napcosecurity.com.On the call today is Richard Soloway, President and CEO of NAPCO Security Technologies; and Kevin Buchel, Senior Vice President and CFO.Before we begin, let me take a moment to read the forward-looking statements. This conference call may contain forward-looking statements that involve numerous risks and uncertainties. Actual results, performance or achievements may differ materially from those anticipated in such forward-looking statements as a result of certain factors, including those set forth in the company’s filings with the SEC.During the call, we may also present certain non-GAAP financial measures such as adjusted EBITDA and certain ratios that are used with these measures. In the press release and on the financial tables issued earlier today, you will find a definition of these non-GAAP financial measures. A reconciliation of these non-GAAP financial measures with the closest GAAP financial measure, as well as a discussion about why we think these non-GAAP financial measures are relevant to our results. These financial measures are included for the benefit of investors and should not be considered instead of GAAP measures.I will turn the call over to Dick in a moment, 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 marketing Boston on February 5th and are continuing to plan more event in other regions during the next few months.Also, on March 17th through the 19th we will be showcasing our product at the ISC West Trade Show at the Sands Expo Convention Center in Las Vegas, Nevada. If you would like to attend ISC West or are interested in having us visit with you for me to arrange more time with us post this earnings call, please contact me. Investor outreach is crucial, especially for small cap company 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 fiscal second quarter 2020 marked another record revenue and profitability performance for NAPCO.Our SaaS recurring revenues continue to grow at a rapid rate. Our recurring revenues annual run rate is now $24 million as of December. Our focus on targeting mostly commercial end markets and professional installation is driving this continuous growth.Our cash balance is continued to grow and our cash balance is clean with no debt. Capitalizing on key industry trends remains our focus. These trends include wireless, fire and intrusion alarm communicators, school security solutions, enterprise access control systems and architectural locking products.Management here at NAPCO continues to focus on key metrics of growth, profits and returns on equity. These metrics are important to us, as well as our shareholders. Our business strategy is executing well and our interests are aligned with our shareholders as senior management at NAPCO owns 38% of the equity.Before I go into greater detail, I will now turn the call over to our CFO, Kevin Buchel, to provide an overview of our fiscal second quarter financial results and then I will be back with more on our strategies and outlook. Kevin?

Thank you, Dick, and good morning, everybody. For the second quarter, net sales increased 4% to $25.8 million, which was a record second quarter performance and the 22nd consecutive quarter of year-over-year record sales, as compared to $24.8 million for the same period a year ago.For the six months ended December 31, 2019, net sales increased 8% to $52.1 million, as compared to $48.2 million last year. The increase in sales for the quarter and the six months were primarily related to increased sales of our alarm communication services and intrusion and access products, as partially offset by a decrease in sales of door locking products.Recurring monthly revenues from the alarm division increased 40% for the quarter and 41% for the six months, and now has an annual run rate of $24 million based on December 2019 recurring revenue.Sales of intrusion and door locking products were affected in the second quarter due to the company’s largest customer, a leading distributor of network and security solutions being in the process of being acquired, the sell-through of our products i.e. sales of these products from this distributor to alarm and locking dealers who ultimately receive our products was strong increasing 15% in Q2 compared to last year and increasing 11% sequentially versus Q1 this year. As a result of this increased demand of our products, it is our belief that the aforementioned impact on sales is temporary.Gross profit for the second quarter increased 14% to $12.1 million with a gross margin of 47%, as compared to $10.7 million with a gross margin of 43% last year. For the six month, gross profit increased 17% to $23.6 million with a gross margin of 45%, as compared to $20.2 million with a gross margin of 42% last year. The 400-basis-point and 300-basis-point increases in…

Kevin, thank you. We continue to believe that growth we have witnessed in our business should continue in the future. Growth drivers for the business are coming from areas of alarm communications for fire intrusion and the smart home category as evidenced by the growth of recurring revenue products.Fire radios in particular are what we call in-house on fire as evidenced by the 81% gross margin for recurring revenue in Q2. Additionally, the school security market remains a contributor to our growth and there is a significant market opportunity here. There are positive tailwinds with our new funding -- with new funding over the past year or so coming down to schools, pay for the upgrades they need.The State of Minnesota recently released $30 million to its schools for security upgrades, which is in addition to the $25 million that was released in 2018. Senator Carlson from Minnesota is currently sponsoring a bill for an additional $500 million in funding and this type of activity is occurring throughout the U.S.Other pending legislation for the school security includes the School Violence Protection and Mitigation Act of 2019, which is proposed by representatives Williams and Deutch in the U.S. House of Representatives in July 2019. This legislation would authorize $2 billion over 10 years to identify and address any shortfall in security at K-12 schools. NAPCO is dedicated to providing all schools with the solutions and products they need to help protect the students and faculty.The funding backdrop plus the continued focus by parents, teachers and students for more school security should continue to have a positive impact on the growth of our business in this vertical. NAPCO announces project wins at schools and universities when the opportunity is allowed for us as we must get approval to make these announcements. Our…

Thank you. [Operator Instructions] Our first question comes from the line of Mike Walkley of Canaccord Genuity. Please proceed with your question.

Great. Thanks for taking my question. First question, just a little more clarity about your large customer going through a sale process, I mean, it sounds like sell-through was strong there. Do you have any indication of how low they want to get their inventory before the sale and any color on the end buyer if they still think your products are right to move through that channel?

Kevin?

Yeah. I believe, Mike, that the sell-through, which is very strong. That’s the first thing we look at, with all of our customers, our distributors, that -- because these distributors their shelf -- they are shelf space for us. The main thing is how is sell-through doing. We saw in this particular case very strong sell-through, both versus a year ago and both -- and versus last Q -- last quarter Q1.So our expectation is, if they are lower -- they lowering their inventory levels or whatever they are doing, and I think it’s, this was more about, they are in the midst of being installed and they kind of like a deer in the headlights freezing, not sure what to do, they have to buy more inventory, but they are going to lose sales.When the sell-through was strong and the demand is there, they don’t want to lose sales. They are going to react maybe this coming quarter that we are in now, maybe it will take another quarter. Ultimately, they have to react, but they are going to lose the sales to another distributor. Remember they are shelf, these ultimate customers the alarm dealers, the locking dealers, those of our ultimate customers.And as long as that demand is there, whether we sell these products through this distributor or someone else, so be it. I believe the new owner is not going to want to lose sales, I think things will get back to normal in the near future. We think this is a temporary thing in the long run.

Okay. No. That’s helpful. And the mix this quarter, both for this recurring revenue and for the equipment sales. Gross margin came in much stronger than what we have seen for a lower revenue quarter, especially on the equipment side, can you talk about the strong gross margin trends and maybe how we should think about them of going forward?

So the recurring revenue, margins, we have been talking -- we always talk about how great they are, it was in the 77% range, 78%, sometimes it even went up to 79%. We have said that as the fire radios become a larger and larger portion of the mix of overall StarLink radios, the margins are going to go up, because fire radios get more money per month than the other radios.And that has begun to happen. And that’s why we have got up to 81% and going forward, listen it might even get better than that. It’s a good thing, whether it’s at 80%, 81%, no matter where it is in that range, it’s very powerful, and of course, we need the recurring revenue itself to keep growing and it did and it’s at $40 million -- at 40% and $24 million run rate, that’s all important.We think the best is yet to come. As Dick mentioned in his comments, we are going to be putting recurring revenue products out in the other areas of the company, the locking and the access control, that’s a project that we are working on and it’s a fiscal ‘21 probably event.But that’s going to be very, very important for us. Because remember the $24 million that we are getting now -- run rate now really only comes from one segment of the business, if you just imagine in the rest of the business, how powerful this could get. So we think 81% maybe that was higher than it will be next quarter, but whether it’s high ‘70s or low 80’s, it’s all a good thing.And then on the margins on the hardware that was very good too, because this quarter obviously we were disappointed in the hardware level. We hit $20 million. We talked about why it wasn’t higher and we believe it will be higher in the upcoming quarter.So we didn’t get Dominican Republic manufacturing leverage that we always talk about. We get that when it goes nicely above the $20 million. But what we did get is a nice mix of high margin products, a bunch of school win, a bunch of access control project, high-margin -- high-margin sales are just as important as the Dominican leverage part of the story, so 37% was very, very good.And going forward, listen, the margins could jump around. Big picture we are going in the right direction. And as we head towards our goal, which is still to get to $100 million of hardware revenue, we said by June of ‘21, maybe it will be a little longer than that, maybe it will take another quarter, we will see. But the big picture that’s where we are going and we still feel very confident that those margins will go up as that happen.

Great. Thanks. And last question from me and I will pass it on. With the strong mix of margins this quarter EBITDA came in line with our expectations with good EBITDA margins. As you look out of the model with recurring revenue growing faster than hardware. How should we think about kind of EBITDA margins in the back half of the year, fiscal year and then longer term as you hit some of your goals and run rates what’s a reasonable long-term adjusted EBITDA target?

Well, EBITDA margin last year was 15%. It was $15 million on basically $100 million. This year the expectation is higher, because obviously, as recurring revenue grows 40% range and at such high margins, EBITDA margins are going to go even higher.In the next couple of years, we expect the EBITDA margins to be 25%. If we get to the point where recurring revenue is in all aspects of the business then down the road, five years from now let’s say, we could be at 50-50 split between recurring revenue and hardware sales. That’s obviously the long-term goal for us in the next five years.At that at those kind of levels we get to that point, EBITDA margins are going to be 30%, 40% and that’s long-term vision. This year obviously if we could get to be above the 15% we were last year, more like 20%. I think that’s the reasonable short-term goal. Long-term, let’s get recurring revenue in all parts of the business, where it becomes the main part of the business. Today Recurring revenue is, like 20% of the total. Let’s get it to the point where it’s 50%. That’s what we are working hard on long-term.

Okay. Thank you. And we look forward to tracking some of the new products as they come into the market.

Great. Thank you.

Our next set of questions comes from the line of Jaeson Schmidt of Lake Street. Please proceed with your question.

Hey, guys. Thanks for you taking my questions. Understanding, sort of the headwinds from this one large customer, can you just talk about what you are seeing from a competitive landscape and if you think you are still gaining share in the market?

Kevin, why don’t you discuss that.

Okay. So, obviously, there’s a competition in the different segments. Remember we are in both the alarms, we are in locking, we are in access control and each competitor within those areas has its own set of issues.So what we have seen in the intrusion, the alarm side of the business is, we have seen our competitors having issues, we have one competitor who has pulled out of the residential intrusion part of the business, because they weren’t getting any recurring revenue and recurring revenues is the name of the game.They pulled out of a segment of the market, which is a great opportunity for us, especially with us coming out with iSecure, that could be very good for us, because we have an offering that will be great for the residential and small business market, priced really well, we have talked about it $99, one hour install and has recurring. So we are going up against a lot of competitors. We go up against some competitors that don’t even make alarm systems. We feel very good about taking market share in the alarm segment.In the locking segment, locking is the biggest part of our business. It fits between our two companies the number one part of the business. They will be fooled by the fact that locking sales were down this quarter, because it is one customer distributor.Overall, locking sales a strong we continue to gain share, winning a bunch of school job, which again we will announce when we can. We have a couple more that we are -- that we have won that, we are trying to get approval on. The locking products -- and they access, they work together because on the university side you need both that has become the strongest part of our business and there’s no reason to believe that getting continue also.And if we get to the point where we have recurring revenue in this look out that could be phenomenal. So, we are not there yet, but we think we are doing all the right things to keep winning more market share. There’s a lot of strong big competitors out there, but we are doing what we can to gain that share.

Okay. That’s helpful. And then just following up on that last comment on adding recurring revenue to locking and access control, after imagine you have discussed this with your customers. Just curious, I know it’s not launching until the summer. But what has customer response into adding that to those two segments?

The customers that this project is aim for don’t necessarily get recurring revenue now, they just do installations and they are paying for those jobs. So the excitement of recurring revenue is a new phenomenon for them.And we know that there is certain traces of service contracts that excite them in certain ways and with our radio communicator locks that will be introducing, they will be able to get and tap into the exciting portions of recurring revenue and we able to sell those to their end user customers because it will offer a lot of advantages over non-reporting type of locking.And because of the fact that it utilizes cellular, it doesn’t utilize the computer departments in these firms that going to be doing business in. So it gets instantaneous data directly from the locking products to the installing dealer and also it will be to central station.So we have a very high confidence rate that it’s going to be a very successful exciting part of growth of our business and we are the major contributors to the 50% recurring revenue in five-year number that Kevin was discussing in this call.So we expect sometime during the summer months, we will be introducing the first versions of it, it will take a while, it will take a year or so for it to get to the point where lots of dealers will understand and be collaborating to use it, like, any new product. But because it builds equity for these installing dealers, they are going to be very happy to get behind it and put equity in their business models. So we are excited about that.

Okay. That’s helpful. And then just lastly, I know you just mentioned kind of 50% recurring revenue target in five years. Do you still feel confident in that $40 million target exiting fiscal ‘21?

Yes. We do.

Perfect. Thanks a lot guys.

Thanks, Jaeson.

Thank you.

Our next set of questions comes from the line of Matt Pfau of William Blair. Please proceed with your question.

Hey, guys. Thanks for taking my questions. I wanted to ask first on the iSecure product and does that contribute at all to the strength and the recurring revenue in the quarter or, and if not, when should we start to expect iSecure to become a more material contributor to that growth?

Kevin, do you want to explain that?

So this quarter, Matt, iSecure shipped the very end of the quarter. So we had 81% recurring revenue gross margin, not because of that. The dealers, the customers, just got it faced of this product at the very end of the quarter.As this becomes a bigger and bigger seller as we have said new products take a few quarters, let’s call it nine months to really have an impact then you will start to see stat even better. Really the stats that you saw this quarter was more about fire radios.When we have our projection of $40 million run rate by the end of ‘21, we need -- we are not even counting iSecure. We think just what we have that’s out there now not counting iSecure, not counting getting recurring revenue and of the locking and access side of the business, we are not counting on that.That’s going to be gravy on what we call in the 40% -- the $40 million run rate by the end of ‘21. So stay tuned, it could be the more exciting than we are say. And one thing I’d like to point out, we say, it’s by the end of June, could it be earlier. Yes. Could it take a little longer. Yes. But it’s in that range that right now we feel are on target to that $40 million.

Yeah. Got it. And then with the new recurring revenue locking and access control products. I think the -- it’s clear with the incentive is for the dealer base to go out and sell these products. From the end customer perspective, these are two areas where there historically has not been a sort of recurring fee associated with them. So how do you go about, I guess, selling the value proposition to the end customer to get them to transition to start paying a recurring fee for some of these unlocking and access control products.

It will come from the functionality that the dealer can offer the end user customer. That functionality in a lot of applications is very powerful, does not exist the data, does not exist the end user customers they get, but he would like to have it because it would help to manage his business better, it would help him build -- help him build a stronger network of employee that work in the office. It gives them additional information that they need to work with. So I can’t get into any more specifics than that, but it’s powerful enough to pull itself over and sell it for a price point to those end user customers.And certain customers we use it certain might not in the beginning, but it’s going to pick up a lot of momentum and it won’t affect the IT department or need IT approval because of the fact it doesn’t get onto the network of the company it’s direct using our cellular radio cloud and that makes it very exciting and much easier to sell into these corporations.

Great. And then last one from me just on the distributor that pulled back on their purchases because we are in an acquisition process. Have you ever seen situation before in your business where there has been disconnect between distributors purchasing and the actual sell through and if so, what is the end result been previously and how long did those situations take to get normalized?

Kevin?

We have seen this on guys trying to lower their inventory level, periodically that happen. They come into the end of the year. They want their inventory to be lower at the end of December. They want it to be virtual distributors just-in-time distributors, which is crazy.But we have seen that. This one was different. I have to think back I don’t remember we are distributor was being sold this is a big transaction. They are a big customer for us. I don’t recall that. But I do know that anytime inventory levels we are adjusted for whatever reason as long as the sell-through is strong, it comes back, that’s the key, we didn’t have that we would be a lot more worried.

Why did you describe the sell-through numbers again, so everybody understands? They have the products checking really well.

Right. So just to reiterate what they work the sell-through for Q2 was up 15% versus last year’s Q2 and the sell-through for Q2 was sequentially up 11%, meaning it was 11% better than it was in Q1. Those are the kind of stats we monitor, we monitor it with all us distributors, not just this one and when it’s that strong it usually mean, got to mean that they will be buying in short orders or otherwise they will lose sales -- they don’t want to lose sales, no matter who it is, whether it the existing owners or new owners.

Right. Okay. That’s it from me guys. Thanks a lot for the additional detail.

Thank you.

Thanks.

Our next set of questions comes from the line of Jeff Kessler of Imperial Capital. Please proceed with your question.

Thank you. Could you part -- can you parse out on your recurring revenue product, the part that’s going into that being sold into 20% of your business that is residential. Are there areas of strength, areas of weakness depending on either the size or the type of end user that ultimately getting that or is it more dependent on the type of dealer who is selling to those end user?

Jeff, the question is, are we stronger in commercial or residential, we are 80% commercial. We feel much more…

All right.

… in the way…

Yeah.

… we do residential.

No. What I am trying -- okay.

I do really parse it out to you, because a lot of the people that are involved as competitors will listen in on what our strategy is. So we can just tell you that 80% of our RMR is on the commercial side and growing very rapidly and it’s complicated commercial, meaning it is commercial that needs a lot of codes and authorities of jurisdiction, fire marshals to agreed to use it and we have been asked that stage, we are into blossoming out our business in self-contained radio cellular communicators and now we are incorporating and building into panels.So we can get both the aftermarket and we can get new business and as the phone companies become less in managing their copper. They don’t want to spend time in repairing copper lines installing copper lines. This will get stronger and stronger and stronger, hence, we feel our 2011 plan and our five-year plan of being 50-50. We believe will come into fruition.

Okay. With regard to LTE and 5G, two are not exactly the same, but they are coming about -- at about the same time in each affect -- each kind of affect each other. Are you -- when you were looking -- talking to your larger -- your commercial customers, what functionality do they want from you that would -- what functionality do they want from you, that is going to affect your view as to what, what type of product do you think is going to sell-through better to them depending on the new technology that is being introduced out there now.

It’s not really the end user that makes a decision. It’s our dealers, our dealers on coverage, reliable coverage in the areas where they do the installations. And also in the commercial business, you don’t need a lot of fast data. Typical -- it’s typical machine-to-machine. So slow data, the type of data you get a LTE works just fine for all alarm and security applications.5G is over kill. It’s like do you need a Ferrari to go to work in the morning or were your SUV work just fine. The Ferrari is not needed. But we have made our products such that you can put a Ferrari engine in them if that’s the only thing available.The manufacturers that make the chips, the service providers like Verizon and AT&T are agreeing to keep the LTE networks going on for years and years and years and therefore right now it’s the best choice as the greatest coverage, the greatest range and that’s with the dealers sell to their customers -- their end-user customer. End-user customer just want service, he wants a monitoring contract, with people that can call the fire and police and medical and the best dealers do that type of work and we still tons of them.

Okay. One other question, as you increase your penetration into adding iSecure and also if you want to call in the generic sense, adding cellular on top of the products that are already out there. Do you see demand from the dealers for -- essentially for adding more than just your cellular add-on or getting -- in fact ultimately getting you involved in on their network in some way or shape that would either present either more obviously complication for you, but also could present more revenue for you as well.

I don’t understand the question. Are you saying beyond locking and access control, beyond fire, beyond intrusion, beyond medical services, beyond all of that?

I am talking about within those verticals.

Yes.

Do you within those verticals do you see any demands for more functionality with the products that you offer -- on top of the products you are offering now?

Yes. We offer a whole menu of services and they pick and choose that menu services. The menu together for all these things, not including the locking and access, which will be coming on Board will be 100 different items that are offered, which are features that are added to our recurring revenue, cellular service, cloud service.So that that’s our plan with everything under our umbrella that we -- that I just enumerated will offer every single feature and if something new comes up over the years that we invent or somebody else comes up with something and they need it made it cellularized into a way where it becomes part of our menu, we will do that also.

Okay. That’s kind of what I was asking then getting out to some of the new features that you are not offering yet that you might that are actually being talked about now, are you able to -- I realize you have competitors on this line. But I am trying to get -- I am just trying to get to some of the new features that you might be able to offer?

Why don’t I invite you to lunch and we can have a tech discussion about this and find exactly where each of us are?

Okay.

Okay.

That’s great. That’s must -- that’s the question that I wanted. And that’s the answer that I got and we will see each other soon.

Okay. Take care.

[Operator Instructions] We have reached the end of the question-and-answer session. I will now turn the call back over to Richard Soloway for any closing remarks.

Thank you. 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. Thank you for your interest and support, and we look forward to speaking to you all again in few months to discuss NAPCO’s fiscal Q3 ‘20 result. Bye-bye.

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