Patrick McKillop - Director, IR Richard Soloway - Chairman, President, CEO Kevin Buchel - Senior VP, Operations and Finance

Allen Klee - Sidoti Dell Wilmington - Delaware Capital

Greetings and welcome to the NAPCO Security Technologies fiscal First Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Mr. Patrick McKillop, Director of Investor Relations for NAPCO Security Technologies. Thank you, sir. You may begin.

Thanks. Good morning. My name is Patrick McKillop, and I'm the Director of IR here for NAPCO Security. Thank you all for joining us for today’s conference call to discuss our financial results for our fiscal first quarter 2017. 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, napcosecurity.com. On the call today with me is Richard Soloway, Chairman and President 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 other 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. With that out of the way, let me turn the call over to Richard Soloway, Chairman and President of NAPCO Security Technologies. Dick, the floor is yours.

Thanks, Patrick. Good morning, everyone. Welcome to the call and thank you for your interest in NAPCO. It's a pleasure for me to be here with you today to discuss our results. The first quarter marked us 6th sequential quarter of record revenue growth. Growth of a 11% is among the best revenue performances we've had in the last several years. This was a really strong revenue performance considering the first quarter is seasonally the weakest period of the year for us. First quarter also marked a milestone in terms of revenue performance. It was the first time we have exceeded $20 million during the first quarter. This is important because of the leverage in our business mode. As we've said before, the $20 million mark is where we begin to see significant expansion in our margin performance. As incremental sales leverage over our fixed cost structure. As a result, the first quarter a 11% increase in sales led to an 80% increase in net income. While still a relatively small piece of our overall revenue, recurring revenue continues to grow at a solid pace up 65% year-over-year. We love recurring revenue as it provides greater margin contribution as well as greater consistency and predictability in our financial results. Growth in alarm communications and the Internet of Things as well as improving school security and safety are the key industry trends that continue to impact our results favourably. And we expect our business strategies will continue to take advantages of these trends and drive greater growth profitability and shareholder returns going forward. Before I go into greater detail, I will now turn the call over to our CFO, Kevin Buchel. He will provide an overall of our 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 first quarter, net sales increased a 11% to $20.2 million which was a record first quarter performance. The increase in sales was primarily related to strength in our alarm products and electronic door locking systems as well as growth in our recurring revenue. Recurring monthly revenue from the alarm division increased 65% for the quarter, and sequentially the increase was 14%. Gross margin for the first quarter was 32% of sales, which was a 90 basis points improvement versus the first quarter last year. The margin improvement was directly related to the operating leverage in our business model and it was only partially offset by an increase investment in R&D to support the launch of new products and services. We've also been investing in sales and marketing to support our new StarLink Connect product which will be launching by the end of this calendar year. This incremental investment was one of the primary drivers of the increase in SG&A cost during the quarter. SG&A cost increased 8% year-over-year to $5.7 million, but as a percentage of sales reduced to 28.4% from 29.3% last year. As Dick mentioned, the operating leverage in our business was clearly evident in the growth in operating and net income during the quarter. Operating margin improved 1.8 percentage points to 3.6% of sales, while operating income increased a 121% to $716,000 as compared to $324,000 last year. During the first quarter net income increased by approximately 80% to $568,000 or $0.03 per diluted share as compared to $315,000 or $0.02 last year. Adjusted EBITDA for the quarter was outlined in this schedule included in today's press release, increased 53% year-over-year to $1.1 million or $0.06 per diluted share. Moving on to cash flows in the balance sheet. We generated $1.9 million in operating cash flow during the first quarter, which was relatively unchanged from the $2.1 million posted during the same period last year. Our working capital can fluctuate significantly from quarter-to-quarter based on several factors, so sometimes difficult to make apple-to-apples comparisons with operating cash flow. During the quarter, we retain $875,000 of our long-term debt which ended the quarter at $3.9 million and our net debt position is now zero. CapEx was a $134,000 during the quarter which was consistent with last year. CapEx this year will likely come in as would be slightly above the higher-end of our normal spending range of $500,000 to $750,000. As we expect to make a relatively small incremental investment in our Amityville facility to expand our shipping and warehouse capacity. I would now tell our production facility in the Dominican Republic has plenty of room to expand before we would need to make an additional investment better. The cash balance grew to $4.7 million from $3.8 million at the end of June. We expect to generate significant cash this year and by the end of the fiscal year, our cash balance should significantly exceed whatever debt remains. That concludes my former remarks and I would now like to return the call back to Dick.

Thanks, Kevin. Our record performance continues to be driven by the two key paradigm shifts that are positively effecting the players in our industry. First is the significant growth in alarm communications and the Internet of Things and second is the significant amount of attention and new spending related to improving school security and safety. Alarms, locks of all types, and access control are one of the first and fastest growing set of devices and systems that benefit from and connect to cellular and internet. As a result there are opportunities for NAPCO to take market share while upgrading install base of existing technologies as well as benefit from accelerated end market growth as customers realize the benefits of connecting these devices and systems to these networks. To take advantage of this paradigm shift, our strategies are focussed on introducing new and innovative products to services that are compelling for the end-user customers as well as products and services that help our dealers grow and succeed. Our StarLink fire and commercial communications continue to experience strong market demand as customers look to use 3G and 4G wireless connections to replace traditional phone lines as well as 2G wireless connections. The phase out or sunset of 2G wireless networks is taking place at the end of this year which we think will continue to drive demand for through the balance of this calendar year as well as into the next. As we highlighted in the press release, we will be unveiling our wireless Internet of Things Cellular communicator named the StarLink Connect controller at the ISC East Tradeshow in New York City this month. This year will be commercially available and at the end of this calendar year, the dealers will be able to get it at their distributors. The StarLink Connect offers a universal cellular solution capable of interfacing with the existing installed base of competitive alarm systems. This opens up the market for our StarLink radios to replace the wireline and 2G wireless connections of not just our own alarm systems, but also the tens of millions of installed alarm systems from other security providers. In addition, StarLink Connect can be used in tandem with our iBridge Connected Home software, which gives customers, control of lighting, heating, cooling, door locks, and remote video viewing and recording from any smart device. It is important to understand that in addition to being a compelling value proposition to the end-user customer expanding the addressable market for StarLink and iBridge will have a positive impact on our recurring revenue streams, which is important driver for growth and profitability for us as well as our channel partners. We have a network of more than 10,000 dealers and 2,000 system integrators. In order to retain and attract new channel partners, it is important that we continue to develop advanced new products that offer the latest capabilities that end-customers desire such as IoT, Internet of Things. Our expanded line of StarLink and iBridge products are easy to install and don’t require significant labour to cut holes in walls, pull wires, etcetera. Also, StarLink and iBridge allow dealers to remotely and more cost effectively program, monitor, and maintain systems as well as as participate in the recurring revenue streams. Clearly, this strategy is working for us. Our channel partner relationships is strong and as Kevin mentioned earlier, recurring revenue increased by 65% this past year. Moving on to a discussion of the other major paradigm shift that is driving our business, the growth of security and safety in school is unfortunate that we continue to hear higher fine news about school security. As both K-12 and universities across America increasingly looked to protect business faculty and administration, we continue to see growing market demand for the LockDown access control system. To address this trend we’ve formed a separate school and campus safety sales division and hired new leadership to head up this dedicated effort. Byron Thurmond joined us in September to head up this division. He is a thought leader in the field of school security and has more than 30 years of direct experience as a practitioner most recently as head of school security and – district, the seventh largest school district in the country. To support this effort we’ve also have a new initiation called project LockDown which incorporates a school access control, vulnerability index or savvy. This is of a priority audit system which takes a holistic and active approach in training school security dealers and end user school official and had a significantly reduced or prevent a mass incident. In addition to our dedicated go-market initiatives, we believe our end-to-end scalable and modular solutions allow us to take market share from our competitors. We are winning business, because system integrators and their customers prefer our solutions that seamlessly integrate access control, fire, intrusion and locking technologies over our competitors’ point solutions, which are more difficult to integrate and maintain. Bid activity is up significantly for our access control products and locked and school campuses, we announced Will San Diego unified school district a few weeks ago and our pipeline of opportunity continues to grow. Before I open up the call for questions, I want cap up my comments by saying, I’m pleased with the company’s direction. We assume strong interest for our recently released products and based on anticipated we’re increasing our investment in sales and marketing to increase the awareness of the active pipeline of new products and services we will be introducing for next year. With the right strategies in place to take advantage of the paradigm that are positively affecting our industry, we’re well positioned to continue to drive top line growth in the high single digit range and continue to generate significant increases in our profitability. Based on the market acceptance of our newly introduced products we believe we’ve the opportunity to accelerate growth into the double-digit range. While we plan to continue to invest the portion of incremental sales contribution to R&D and sales talent, we expect to continue to demonstrate the operating leverage in our business. As incremental sales contributions leveraged overall fixed cost, we expect our bottom line will continue to grow at twice the rate of our top line and in turn continue to enhance returns and create shareholder value. That concludes our formal remarks. Kevin and I would like to open the call for questions. Operator, please proceed.

[Operator Instructions] Our first question comes from the line of [Indiscernible] please go ahead.

Hi, good morning, thanks for taking my questions. Can you talk a little bit about the expected sales cycle of newly rolled out StarLink and then when might it becoming meaningful contributor to your top line?

We’ve three StarLink products now, the original was been out for a couple of years, it was residential small business, then seven months ago, we introduced the StarLink commercial fire version of it. And now by the end of this year, it will be the StarLink Connect. These products, there is a gestation period by the dealers because they want to get trail and get used to it. So, I’d say ramping of fiscal 2017 we should get nice returns sales wise on these products. The commercial fire version that was introduced seven months ago, we’re in the second inning of it, acceptance I would say and doing very, very well and StarLink connect we expect to also to do exceptionally well. So, there is a little bit of period here with the dealers who are mechanically oriented and they want to make sure they all have any issues, they like to do trial and takes a little bit of time.

Great, and then my follow up is, should we expect any incremental sales investments to effectively market the StarLink connect product or the channel partners essentially drive adoption there and put the cost?

I believe that we’ve made most of these investments already by expanding the sales department and the support we’ve with the engineering department. So it’s matter of doing lots of training sessions, bidding the dealers and distributors and trade shows and making the dealers understand how it works. It’s very revolutionary from the fact that it upgrades the older systems that have been installed less 25 years out there and now you can hear moderate smartphone apps to it and it also is a combination communicator. So it’s two devices in one and you don’t have to rip out the whole alarms anymore to get a modern alarm, just add install and connect. So it’s a little bit of a training period that we’re going to be going through, but it should be very successful.

Great, thanks so much.

Our next question comes from the line of Allen Klee with Sidoti, please go ahead sir.

Good morning. Recurring revenue is now what percent of total revenue and where do you think that could go to overtime?

We don’t disclose the period number Allen, we’ve said that with up 65%, we’ve also given the run rate stats which I can’t give you that. So, we’re running at about a $6.8 million run rate so you can do the math, we’re getting very close to the 10%, we also said publicly that we think we will get to $10 million of recurring revenue in two years, it looks like it will be rest in that but to be conservative that we’ve said, and remember recurring revenue has a 90% gross margin.

Thank you. And then, just a little bit more on the competitive environment and why you think that you guys have an advantage?

Well, we’re the only company that has the three key legs of the security stool, we manufacture alarms of connectivity now and we manufacture access control systems and we manufacture mechanical and electronic locking products. So, there is no manufacturer that has us, who likes – of product line so what happens is when an integrator wants to do any type of building he can use all NAPCO products and they all play and work well together, we do all of our application work with our tech service department here in our zone. It’s like if you try in the world that we all understand, if you try to use a Window product and an Apple product together there is a lot of collision. So when the various competitive manufacturers put systems together with other manufacturers there is a lot of technical difficulty. But with NAPCO you don’t have that. Our families, companies all support each other and all the technology works well together. So because of that we’re picking up share of jobs which are integrated jobs. When it comes incident of things and solely communications we’ve a very strong offering with our StarLink line and in the period of two years we went from zero recovery revenue when we introduced the product as Kevin says in the sixes already, $6 million of recurring revenue and now we’re going to be introducing this recurrent revolutionary StarLink connect which is to the rises in one and it’s very easy for the dealer to install it, get more recurring revenue from sales as well as for us and lots of people want to upgrade their older alarm systems to do modern control of everything electronic in the home. So that’s going to be, we expect to be a nice strong product for years come. Now other competitors already think like this.

And then just, you kind of touched on, which is following up so from a customers’ perspective who is thinking about a new product, what are the advantages for – about the StarLink connect product that you’re going to later this year?

Q - Allen Klee: So, by offering products such as the StarLink line of products and the iBridge line of products, it gets them more recurring revenue from their accounts. As an example, if they were monitoring a business and they were charging the business $25 a month or $30 a month for fire monitoring and burglary monitoring, same thing for the residential and now we can give them Internet of Things where the consumer wants control of their thermostat and their lights and to see live video and they can get another $10 a month with their existing accounts and then get new accounts with this new technology. It's a very exciting time for them. That's why at the International Security Conference in Las Vegas at the beginning of this year, we showed all these products together, we had a lot of excitement that the dealers standing 10, 20 deep watching these products function because these are live demonstrations. We're going to do the same thing in New York this month at the Javits Center. We'll welcome everybody that would like to come to the Javits Center to contact us and we'll get you passes and you can see us and see the dealers and see what the excitement level is all about. A - Richard Soloway: So, by offering products such as the StarLink line of products and the iBridge line of products, it gets them more recurring revenue from their accounts. As an example, if they were monitoring a business and they were charging the business $25 a month or $30 a month for fire monitoring and burglary monitoring, same thing for the residential and now we can give them Internet of Things where the consumer wants control of their thermostat and their lights and to see live video and they can get another $10 a month with their existing accounts and then get new accounts with this new technology. It's a very exciting time for them. That's why at the International Security Conference in Las Vegas at the beginning of this year, we showed all these products together, we had a lot of excitement that the dealers standing 10, 20 deep watching these products function because these are live demonstrations. We're going to do the same thing in New York this month at the Javits Center. We'll welcome everybody that would like to come to the Javits Center to contact us and we'll get you passes and you can see us and see the dealers and see what the excitement level is all about. Q - Allen Klee: So, by offering products such as the StarLink line of products and the iBridge line of products, it gets them more recurring revenue from their accounts. As an example, if they were monitoring a business and they were charging the business $25 a month or $30 a month for fire monitoring and burglary monitoring, same thing for the residential and now we can give them Internet of Things where the consumer wants control of their thermostat and their lights and to see live video and they can get another $10 a month with their existing accounts and then get new accounts with this new technology. It's a very exciting time for them. That's why at the International Security Conference in Las Vegas at the beginning of this year, we showed all these products together, we had a lot of excitement that the dealers standing 10, 20 deep watching these products function because these are live demonstrations. We're going to do the same thing in New York this month at the Javits Center. We'll welcome everybody that would like to come to the Javits Center to contact us and we'll get you passes and you can see us and see the dealers and see what the excitement level is all about. A - Richard Soloway: So, by offering products such as the StarLink line of products and the iBridge line of products, it gets them more recurring revenue from their accounts. As an example, if they were monitoring a business and they were charging the business $25 a month or $30 a month for fire monitoring and burglary monitoring, same thing for the residential and now we can give them Internet of Things where the consumer wants control of their thermostat and their lights and to see live video and they can get another $10 a month with their existing accounts and then get new accounts with this new technology. It's a very exciting time for them. That's why at the International Security Conference in Las Vegas at the beginning of this year, we showed all these products together, we had a lot of excitement that the dealers standing 10, 20 deep watching these products function because these are live demonstrations. We're going to do the same thing in New York this month at the Javits Center. We'll welcome everybody that would like to come to the Javits Center to contact us and we'll get you passes and you can see us and see the dealers and see what the excitement level is all about. Q - Allen Klee: So, by offering products such as the StarLink line of products and the iBridge line of products, it gets them more recurring revenue from their accounts. As an example, if they were monitoring a business and they were charging the business $25 a month or $30 a month for fire monitoring and burglary monitoring, same thing for the residential and now we can give them Internet of Things where the consumer wants control of their thermostat and their lights and to see live video and they can get another $10 a month with their existing accounts and then get new accounts with this new technology. It's a very exciting time for them. That's why at the International Security Conference in Las Vegas at the beginning of this year, we showed all these products together, we had a lot of excitement that the dealers standing 10, 20 deep watching these products function because these are live demonstrations. We're going to do the same thing in New York this month at the Javits Center. We'll welcome everybody that would like to come to the Javits Center to contact us and we'll get you passes and you can see us and see the dealers and see what the excitement level is all about. A - Richard Soloway: So, by offering products such as the StarLink line of products and the iBridge line of products, it gets them more recurring revenue from their accounts. As an example, if they were monitoring a business and they were charging the business $25 a month or $30 a month for fire monitoring and burglary monitoring, same thing for the residential and now we can give them Internet of Things where the consumer wants control of their thermostat and their lights and to see live video and they can get another $10 a month with their existing accounts and then get new accounts with this new technology. It's a very exciting time for them. That's why at the International Security Conference in Las Vegas at the beginning of this year, we showed all these products together, we had a lot of excitement that the dealers standing 10, 20 deep watching these products function because these are live demonstrations. We're going to do the same thing in New York this month at the Javits Center. We'll welcome everybody that would like to come to the Javits Center to contact us and we'll get you passes and you can see us and see the dealers and see what the excitement level is all about.

Great, thanks.

And our next question comes from the line of Dell Wilmington from Delaware Capital. Please go ahead.

Yes. Quick question. In terms of this school security system. I know you sell in there, right. So, who do you sell, to the schools, the district, or the state?

It is to the school district, each school district for the most part K-12. They make their own decision, same thing with the colleges and universities. So, I guess they work with a budget and that’s how they do it. The penetration level in school security is not very high, yet, but there is legislation coming through state legislation which is going to try to organize everything for the schools and for the K-12's as well as colleges and universities. So, there's going to be some mandated school security equipment. We have the widest range of electromechanical and radio controlled school lock and equipment that could do any sized job at all kinds of price points. So, with our sales def. around the country, our sales reps and our new head of the school vertical, we expect that we're going to be retooling lots of schools with the security products.

Could you quantify this side a bit more, how big is it?

It's a billion dollar business, multi-billion dollar business essentially. Imagine, I mean, we do all kinds of jobs, we're constantly getting jobs for $50,000 and a $100,000, $75,000, some jobs are a million dollar job. So, that's our piece of the job. Then the dealer adds his labour content to that. We don’t do any installations, we just sell through the dealer integrated channel, but we do sit in of course with the school administrations and the architects of the schools and they select the offering that we think is best and is value engineered for those schools.

Thanks a million.

Thank you.

There are no further questions at this time. I'll turn the call back over to management for any closing remarks.

Okay. 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 me. 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 '17 results. Also, if anybody wants to come to the Javits Center and see the dealers, let us know, then will see our exhibit, then will see our products functioning and you'll get a better view of the industry. So, have a great day everybody and bye-bye.

Thank you, gentlemen. And then this conclude our teleconference for today. And we thank you for your time and participation. You may disconnect your lines this time. And enjoy the rest of your day.