NAPCO Security Technologies - Q1 2024

Transcript

Operator (participant)

Welcome to the NAPCO Security Technologies Fiscal Q1 2024 Earnings Call. Our host for today's call is Fran Okoniewski, Vice President of Investor Relations. At this time, all participants will be in a listen-only mode. Later, we will conduct a question and answer session. I would now like to turn the call over to your host. Fran, you may begin.

Fran Okoniewski (VP of Investor Relations)

Thank you, Ross, and good morning, everyone. My name is Fran Okoniewski, Vice President of Investor Relations for NAPCO Security Technologies. Thank you all for joining us for today's conference call to discuss our financial results for our fiscal first 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 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 are Richard Soloway, our President and Chief Executive Officer of NAPCO Security Technologies, and Kevin Buchel, our Executive Vice President and Chief Financial Officer.

Before we begin, let me take a moment to read the forward-looking statement, 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 or underlying assumptions subsequently proving to be incorrect, could cause actual results to differ materially from those in the forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance, or achievements. You should not place undue reliance on these forward-looking statements. All information 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 that we will be attending the ISC East Industry Trade Show on November fifteenth and sixteenth in New York City's Javits Center.

If anyone is interested in attending and meeting with us, please contact me and I will arrange to get you a pass. In addition, we will be attending the twenty-sixth Annual Needham Growth Conference in January. We're also planning for some non-deal roadshow activity in the near future. With that out of the way, let me turn the call over to Richard Soloway, President and Chief Executive Officer of NAPCO Security Technologies. Dick, the floor is yours.

Richard Soloway (President and CEO)

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 Q1 2024 record sales of $41.7 million. This is the 12th consecutive quarter we achieved record sales for a quarterly reporting period. Recurring revenue service continues to grow at a very strong rate, and the annual prospective run rate is now $72.5 million, based on October 2023 recurring revenues. Our balance sheet remains strong, with our cash balances at $74.6 million, up 68% over fiscal Q1 2023, and up 12% sequentially. 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 revenue service, 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, and 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'll provide an overview of our fiscal first quarter results, and then I'll be back with more on our strategies and view of our markets. Kevin?

Kevin Buchel (EVP and CFO)

Thank you, Dick, and good morning, everybody. Net sales for the three months ended September 30, 2023, increased by 6% to a fiscal first quarter record of $41.7 million, as compared to $39.5 million for the same period last year. Recurring monthly service revenue continued its strong growth, increasing 25% in Q1 to $17.3 million, compared to $13.8 million for the same period last year. Our recurring service revenues now have a prospective annual run rate of approximately $72.5 million, based on October 2023 recurring service revenues, and that compares to $67 million based on July 2023 recurring service revenues, which we reported back in August.

Equipment sales for the quarter decreased 5% to $24.4 million, as compared to $25.7 million last year. This decrease was primarily due to the expected softness in radio sales as some distributors work off excess inventory, which was the result of distributors loading up with radios when the impending 3G Verizon sunset was approaching, and they wanted to ensure that they had updated 5G radios in their inventory. This was partially offset by increases in both our Alarm Lock and our Marks door locking products, which increased 24% in Q1 versus last year's Q1. We believe the excess radio inventory in the channel is a temporary situation, and we expect radio sales to continue to be a key contributor to our hardware sales and lead to the continued growth of our highly profitable recurring revenue.

Gross profit for the three months ended September 30, 2023, increased 54% to $22.4 million, with a gross margin of 54%, and that compares to $14.6 million, with a gross margin of 37% for the same period a year ago. Gross profit for equipment sales for Q1 increased 188% to $6.9 million, with a gross margin of 28%, and that compares to $2.4 million with a gross margin of 9% last year. Gross profit for recurring revenues for the first quarter increased 28% to $15.6 million, with a 90% gross margin, and that compares to $12.2 million with a gross margin of 88% for the same period last year.

The increase in gross profit dollars and gross margin for equipment sales was primarily the result of more normalized material and freight costs after the cessation of the global supply chain problems, as well as the shift in product mix to higher margin locking products. The 200 basis point increase in gross margin on service revenues, now 90%, was primarily due to the continued increase in service revenues relating to the company's fire radios, which have higher monthly selling prices than the company's intrusion radios. Research and development costs for the quarter remain relatively constant at $2.4 million, or 6% of sales, for both Q1 this year as well as Q1 last year.

Selling general and administrative expenses for the quarter were also relatively constant at $8.4 million, or 20% of net sales, as compared to $8.5 million, or 22% of net sales last year. Operating income for the quarter increased 222% to $11.6 million, as compared to $3.6 million for the same period last year. The company's provision for income taxes for the three months ended September 30, 2023, increased by approximately $1.1 million-$1.5 million, with an effective tax rate of 13%, as compared to $461,000, with an effective tax rate of 13% for the same period a year ago. The increase in the provision for income taxes for the three months was primarily due to higher taxable income.

Net income for the quarter increased 239% to a Q1 record $10.5 million, or 28 cents per diluted share, as compared to $3.1 million, or 8 cents per diluted share for the same period last year, and it represents 25% of net sales. Adjusted EBITDA for the quarter increased 174% to a Q1 record $12.9 million, or 35 cents per diluted share, and that compares to $4.7 million or 13 cents per diluted share for the same period last year, and equates to an Adjusted EBITDA margin of 31%. Moving on to the balance sheet.

At September 30, 2023, the company had $74.6 million in cash, cash equivalents, and marketable securities, and that compared to $66.7 million at June 30, 2023, and that represents a 12% increase. Working capital is defined as current assets less current liabilities, was $115.9 million at September 30, 2023, and that compares with working capital of $111.7 million at June 30, 2023. The current ratio, defined as current assets divided by current liabilities, was 6.3-1 at September 30, 2023, and was 6.7-1 at June 30, 2023.

Cash provided by operating activities for the three months ended September 30, 2023, was $11.2 million, and that compared to cash used in operating activities of $2 million for the same period last year. CapEx for the quarter was $256,000, and that compared to $372,000 in the prior period last year. This concludes my formal remarks, and I would now like to return the call back to Dick.

Richard Soloway (President and CEO)

Kevin, thank you. As I mentioned, our fiscal 2024 is off to a great start, with fiscal Q1 results achieving record profits driven by hardware-enabled recurring revenue growth of 25%, representing 41% of total company revenues. Total company revenues were up 6% year-over-year, and we achieved gross profit growth of 54% to $22.4 million. While our equipment revenue declined by 5%, gross margins on such sales increased to 28%, and our recurring revenue grew by 25% to $17.3 million, with an annual run rate of $72.5 million as of October 2023. Our locking sales from our Alarm Lock and Marks divisions, which represents 62% of our hardware sales, increased 24% in Q1 versus last year's Q1.

As we work through channel inventory, we expect equipment revenues to re-accelerate as thousands of 3G radios need to be replaced, and we anticipate these will be replaced with NAPCO's newer generation radios because alarm dealers must have new functioning and recurring revenue-producing radios to monitor alarm conditions. This would result in both additional hardware revenue and increasing recurring revenue for the company. We continue to focus on our previously stated goals of a $150 million run rate in recurring revenue and $150 million of equipment revenue on or about the end of fiscal 2026. Achieving these goals, as well as our gross margin goals of 80% for recurring revenue, and it was 90% here in Q1, and a 50% goal for equipment, would generate EBITDA margins in excess of 45%.

We are well on our way to achieving this goal as our EBITDA margin in Q1 was 31%. There are thousands of commercial buildings of all types, such as offices, hospitals, schools, coffee shops, restaurants, and others that still require upgrades from legacy copper phone lines. Our StarLink line of radios have the widest coverage range of both AT&T and Verizon, with rich feature sets which our dealers love. Margins for recurring revenue improved by 200 basis points to 90% this quarter versus 88% in the same period a year ago. As we have previously stated, the constraints of the supply chain are abating, and we believe in the coming months that, combined with new distribution sources we have developed, will begin to reinvigorate our equipment sales to even higher levels than any time before.

When that happens, we also expect to generate increased hardware gross margins as the higher the level of hardware sales, the more overhead absorption occurs in our Dominican Republic factory, and this expands our gross margins. We also announced the hiring of Deloitte & Touche as our new accounting firm. Deloitte has one of the largest professional service networks in the world and is known for their renowned reputation, expertise, and having a strong track record of providing high quality audit and advisory services to a wide range of clients.

Kevin Buchel (EVP and CFO)

...At this stage, for NAPCO, it's essential to choose a Big Four firm with industry-specific experience that aligns with our organization and who understands the unique challenges and regulations relevant to our sector. An additional highlight in this quarter was the partnering with one of the largest alarm product distributors in the USA, with over 100 branches across the country to service alarm dealers, system integrators, and locking professionals. And with this new relationship, our distribution network expands to over 300 locations. Our R&D team remains hard at work, developing more products for the future, which will help us grow our recurring revenue business. In October 2023, we introduced a new high-volume, small business, residential burglar fire alarm called Prima, which could generate substantial growth in hardware sales and profits, and most importantly, add substantial recurring revenue service to NAPCO.

Also, in the quarter, we have made some strategic investments in personnel, adding to the existing talent of our team. These additions in engineering and specialized sales will help us continue to develop more new and exciting products faster and take them to market in new ways so as to get our alarm, locking, and integrators excited. Lastly, as indicated in the earnings release, we will be issuing another $0.08 per share dividend, and we are proud of this program, as the NAPCO team has created such tremendous shareholder value over the years, and this is another way for us to distribute profitable growth to investors. We are off to a great start for fiscal 2024, and we have a pristine balance sheet, no debt, and continue to generate strong sales and healthy profits.

We believe we can continue this growth well into the future as we work toward our fiscal 2026 goals and beyond. I'd like to thank everyone for their support and for joining us in this exciting future we have. Our formal remarks are now concluded, and we would like to open the call for the Q&A session. Russ, please proceed.

Operator (participant)

If you would like to ask a question, please press star one on your telephone keypad now, and you will be placed into the queue in the order received. Please be prepared to ask your question when prompted. Once again, if you would like to ask a question, please press star one on your phone now. Our first question comes from Matt Pfau from William Blair. Please go ahead, Matt.

Matt Pfau (Equity Research Analyst in Technology and Software Coverage)

Hey, guys. Thanks for taking my questions and nice results. Wanted to just first ask on the accounting restatements that you had. Looked like you've changed the auditor to help address that. Anything else you're doing internally to help address some of those past issues, and how should we think about those impacting your expenses? Thanks.

Kevin Buchel (EVP and CFO)

Thanks, Matt. So we've done a few things. One, our procedures at the end of the quarter is different than it was in the past. We perform price testing on any large items that are in the raw materials. We compare it to what we had. If there's any changes, we adjust it. We do the same thing in October on a test basis, and we continue to investigate any changes that might have occurred. We didn't see hardly any changes in this past quarter. We didn't expect to see any changes. The supply chain crisis, the chaos that it brought with it is over, and that's really what caused these changes in pricing in the last year.

But we still check it, and we are investing in a module that will do a lot of this quicker and in a more automated fashion, and we expect that to be live by Q3. We hired a consulting firm to work with us to get our procedures and policies and internal controls to be perfect so that we don't have any weaknesses or no deficiencies. They will be working hand in hand with Deloitte. Deloitte will start right after we file our Q1, which will be in the next day or two. Once that Q is filed, Deloitte becomes our new accountants. They will work hand in hand with the consultant. We plan on hiring an internal control auditor on our staff. We plan on hiring 2 industrial engineers to focus on the material and the labor costings.

Each of these things is in motion. We haven't felt the impact of any of them yet, because this is all happening now. So over the next 12 months, we'll start to see the expense impact of this. My guess is it'll cost up to $1 million over the course of a year. So if you measured us from October through the following September, it'll probably be $1 million more than what we've seen, up to $1 million. All well worth it, and we're looking forward to working closely with both Deloitte and our consulting firm.

Matt Pfau (Equity Research Analyst in Technology and Software Coverage)

Got it. That's helpful, and wanted to follow up on the equipment revenue results. So it sounds like there was, you know, some continued weakness in radio sales, but strength in other areas to help offset that. Can you give us an idea of, you know, the revenue and performance by segment there so we can better understand, you know, what's going on in the equipment business? Thanks.

Kevin Buchel (EVP and CFO)

Right. So, you'll see this in the queue when it gets filed, either later today or in the next couple of days. I'm not sure exactly when it's gonna be, but it'll be soon. There's a table, it's in footnote 2, and it shows the breakout between intrusion and access alarm products, door locking devices, and recurring revenue. So in this quarter that we just completed, the intrusion and access alarm products was $9.3 million. Door locking products was $15.1 million, and the recurring, which you can also see on the income statement, was $17.3 million. The intrusion part was down. We expected it to be down.

Last year, a year ago at this time, we were in what I call radio mania, where everybody was loading up, trying to get their hands on as many radios as they could, given the impending 3G sunset, which was occurring January of 2023, which did happen. A lot of dealers are last-minute guys, but they were scrambling around to load up, and there wasn't a lot of choices either. A lot of our competitors were having trouble delivering. You remember, going back a year ago, we were in the midst of supply chain issues. Nobody could get their hands on the micros that are required in these radios. We were able to get our hands on it, and we spent the money to get our hands on it. We spent extra money buying these chips from brokers.

We did whatever we could to keep things moving, 'cause we knew how, A, how important it was to get radios in the hands of all the dealers, but also we know that it leads to recurring revenue. And we, as we've talked about before, picked up some new large accounts because we were able to deliver and others couldn't. And, some distributors just bought up whatever they could get their hands on. So not a surprise. Now, that inventory has to be worked off now that the sunset is, has come and gone. And, you know, we were encouraged. We saw that the sell-through stats for Q1 were better than they were in Q4. We knew they were gonna be less than they were a year ago, not a surprise, but we worked very closely with our distributors to help them move this equipment through.

Opening up also a brand-new, large distributor with over 100 locations is gonna help move overall radio inventory. That we expect to happen. We've seen signs of that already, so that's encouraging. And from a locking point of view, the locking... We have two companies, Alarm Lock and Marks. They've both been doing great for several quarters in a row. It's attributable to infrastructure upgrades at airports. It's attributable to school security, a bunch of school jobs that we're getting. Can't announce it. A lot of times the schools don't let us, but we see it, we hear about it, we know about it. Hospitals, buildings that wanna go to a more upgradable locking setup, where you don't have to use a key, big projects with hotels. It's happening all over.

We're very encouraged by the strength of the locking business, and of course, the locking margins are better than, say, the radio margins. But radio, radio margins might be 20%. Of course, it leads to the recurring locking margins, mid-30s%-over 40%. So that helped, helped the overall gross margin for the quarter.

Matt Pfau (Equity Research Analyst in Technology and Software Coverage)

Great. Appreciate the additional detail and you taking my questions. Thanks.

Kevin Buchel (EVP and CFO)

Thanks, Matt.

Operator (participant)

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

Jim Ricchiuti (Managing Director and Senior Equity Research Analyst in Advanced Industrial and Environmental Technologies)

Hi, thank you. Wanted to get a little bit more color, if we could, on the new distribution source that you're talking about. Sounds like this has the potential to be another important channel for you guys. I wonder if you could elaborate on how quickly that might scale.

Kevin Buchel (EVP and CFO)

The new distribution source is another distributor, which is the largest in the industry. They came to us at the last ISC West show in Las Vegas and said, "We would like to be able to market your products. We have a great network throughout the USA." They have 115 branches.

Richard Soloway (President and CEO)

... and train our guys, and we will be a great customer for you. They have a lot of customers there that are new, that we don't have. We have approximately 12,000 dealers, all independent business people that run alarm companies and system integration companies. So this new distributor has additional companies they, they're gonna bring to us to sell our products. We're very, very unique, the most unique company in the security industry because we manufacture fire alarms, burglar alarms, locking products, and access products. There's no one manufacturer that has all those segments, so we have a great ability with our sales group to explain to these new customers how we have an integrated solution, and we expect it to add a lot of additional volume to our business.

So now we have about 300 branches between our independent network, which are fabulous guys that have a great customer base, and this new network. There's gonna be lots of NAPCO company products out there, and a lot of our salesmen, as we said, we've added additional salespeople, to help sell it and to break in these distributors as to what we make and why it's so, has such great advantages over anything on the marketplace. So looking for exciting future with our new distributor.

Jim Ricchiuti (Managing Director and Senior Equity Research Analyst in Advanced Industrial and Environmental Technologies)

Dick, what kind of traction are you seeing? I know it's early days with, with Prima, but I'm wondering if you can give us a sense as to how you see that potentially ramping as you go through the year. And I assume the margin profile of this is a little bit lower in terms of as we think about recurring revenue. And I wonder if you could also talk to whether there might be some cannibalization of your, perhaps some of your higher priced offerings.

Richard Soloway (President and CEO)

The new Prima is completely different than anything else we have in our line. We've been making products called Gemini. The dealers love it. It's rock solid. It's fire alarms, it's burglar alarms. And now Prima is a different type of product. It's a product designed for smaller enterprises. It's totally wireless. It can go either small business or residential. It installs in, we like to say, five minutes because it's a lick-and-stick type of product, but it's very, very reliable. Has NAPCO quality to it, NAPCO feature sets in it. So you have a nine-inch keypad that could be put near the front door of a store or a home, and it has additional satellite keypads, has motion detectors, it has electronic doorbell cameras.

It has very, very unique features which make it easy for the dealer that's selling the job to actually install it right after the job is sold. Or he can leave it to the customer, and the customer can install himself if he's handy, a handy type of customer. It reports to any central station the dealer is comfortable with, that he's been using for his regular Gemini line of equipment. And we get recurring revenue for everyone because it's all added to our NOC. It's enrolled in our NOC, and we get a service fee, like we do for any of our products. The dealer also charges the end user customer whatever the market will bear for the type of system the dealer leaves behind. So it's a win-win for dealers, and it's a win-win for us.

The volume we expect from this is gonna be a very, very high volume because there's lots of stores, lots of residences that need this type of product. And it's very, very good for the dealer to utilize this product because this product also eliminates, has technical features in it that nothing else on the market has, and eliminates truck rolls by the dealer for repairing and adjusting the system because it's all self-adjusting. If somebody has a Wi-Fi issue, somebody disconnects the Wi-Fi in a residence, like, kids like to play with the Wi-Fi, the network. Currently, the dealers have to go back to that site and reboot and realign all the equipment. With Prima, it's all automatic. It refines the network, and it reboots itself on many, many different levels.

So the dealer won't have to go back and roll the truck. So that's a great boon for the dealer. Not only does it have all the fancy features and installs quickly, but it also is, we call, self-healing, if the system is interrupted, with people that are changing the Wi-Fi or adjusting the Wi-Fi system. So it has a lot of features to it, so we expect a lot of great things out of it. We started shipping it last month. Typically, it takes nine months to a year for a product really to grip and get volume. This works very similar to Gemini and other products on the marketplace, so I think the learning curve is gonna be quicker.

Jim Ricchiuti (Managing Director and Senior Equity Research Analyst in Advanced Industrial and Environmental Technologies)

... Got it. Thank you. You guys are running into some tougher comps now as we think about the door lock and device business. I wonder, you know, what's your, what's your line of sight into that business as you look out over the next?

Kevin Buchel (EVP and CFO)

Well, the locking business is a strong business for us and has a lot of tech. Our products have a lot of tech. When the business was started, I wanted the business to be very technical, and we acquired two companies which basically made mechanical things, locks, and traditional type of mechanical locks like everybody else in the business. But our idea was to add technology to it, add radios to it, so it transmits over distance. Add cell phone communications to the locks. Add so many different things to the locks that it made locks modern. So while we still make traditional hardware, mechanical locks, we also make a whole line of electronic-oriented, which use near-field, Z-Wave, cellular, because now we're getting locks. We're making locks for the dealers that never got recurring revenue before.

A whole line of locks, where it's installed by the dealer, but they get recurring revenue from the customer and for themselves. Never been done before in this business. So that's what it is. We bring a lot of technology to the mechanical locking business, and it's really paying off, and we expect it to continue to pay off in the future.

Jim Ricchiuti (Managing Director and Senior Equity Research Analyst in Advanced Industrial and Environmental Technologies)

Got it. And it's final question, I'll jump back in the queue. Kevin, any sense as to, you know, where we are in terms of the higher price components that you had in inventory, in terms of where we are in burning that off?

Kevin Buchel (EVP and CFO)

Yeah, we're not buying anything now at the higher pricing. Those days are over. We have to work through some radio inventory because, like, some of the distributors, we have some extra radio inventory as well. It's a mixed bag. Some of it was priced at higher component costs, some of it at normal component costs. So that's why, for this past quarter, you saw a Gross Margin of 28% on hardware, which was great compared to kind of what it's been. It's gonna get better as the year progresses for two reasons: one, we're gonna not have hardly any of the high radio costs in inventory anymore as we go through it.

And of course, as the volume picks up and our volumes get stronger as the year progresses, typically, Q2 being better than one, three being better than two, four being better than three on the hardware side, we get that overhead absorption, the margins expand. So I'm a conservative guy. I was happy to see 28%. As we move into the balance of fiscal 2024, my expectation is that these margins will continue to expand even further.

Jim Ricchiuti (Managing Director and Senior Equity Research Analyst in Advanced Industrial and Environmental Technologies)

Got it. Thank you.

Operator (participant)

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

Jaeson Schmidt (Director of Research and Senior Research Analyst in Equity Research)

Hey, guys. Thanks for taking my questions. Just curious if you could provide some color on what you saw from distributor sell-through in the September quarter. And then relatedly, obviously, you continue to kinda go through this inventory digestion period. When do you think that period is over? Is it largely gonna be over in this current quarter?

Kevin Buchel (EVP and CFO)

We had said, give it a couple of quarters to work so that the distributors could work through the inventory. This was the first of the 2. So I think we have another quarter to work it through. We're working with our distributors to help them lower their inventory levels on the radios. Having this new distributor helps a lot. It's gonna help the stats a lot. They're gonna move it, I think, at much better paces than the couple of guys that have excess. We were encouraged in the sell-through stats. While the sell-through stats on the intrusion guys showed it was lower, our stats were lower than they were a year ago, which we expected because of the radios. We did see it was better than Q4, so sequentially, it was up.

That, to me, shows it's starting to move in the right direction, and so we're very encouraged by that. But I would give this, we said two quarters. We just saw one, another quarter, and we think this second quarter of the two will be better than the one we just did, and then by Q3 for us, it's more normalized. But whatever it's gonna take, we're gonna work with the distributors to move it through. Been through this before, this is no different. We'll put in whatever effort it takes.

Jaeson Schmidt (Director of Research and Senior Research Analyst in Equity Research)

Okay, that's helpful. And then just as a follow-up, I know you guys are limited what you can announce in the school security market, but just curious if you could provide an update, what are you seeing in that space?

Kevin Buchel (EVP and CFO)

Yeah, I wish we could announce more because I hear about... I don't hear about everyone, because sometimes the schools go direct to the distributors... and the distributors just sell to the schools, the school districts. But I do hear about some, and I'm always begging to be able to announce it, and there, there's usually a reluctance. They don't. They like to keep things off the radar. Some let us, some don't. But the school business is still a key part of locking. It's one of the reasons why the locking sales have grown. That infrastructure upgrades in airports, upgrades in hospitals, et cetera, things I mentioned before, they're all key to the locking business, but schools is a part of it, and again, when we can announce it, we will. We are seeing that the schools are no longer waiting to...

for the kids to be out of school. It used to be that this was somewhat of a seasonal thing. The kids are out of school for the winter break. That's when the jobs would get done, or the kids are out of school in the universities by May, and that's when the jobs would get done. Happening now, we see it all year round. Schools can't afford to wait, too much at stake. There's no real seasonality to it, and so we're working hard, banging on the doors of all the school districts. You know, there's lots of K through 12s out there, and there's over 5,000 universities. And even though we've been talking about this for years, still many, many schools, most I would say, still don't have equipment that would prevent tragedies. So we always say...

They, they ask me, "What inning are we in, in the school segment, school security segment?" And I say, "It's still early innings, despite all the things that have gone on.

Jaeson Schmidt (Director of Research and Senior Research Analyst in Equity Research)

Okay. Appreciate that, caller. Thanks a lot, guys.

Kevin Buchel (EVP and CFO)

Thanks, Jason.

Operator (participant)

Our next question comes from Raj Sharma, from B. Riley Securities. Please go ahead, Raj.

Raj Sharma (Senior Analyst)

Hi. Thank you for taking my question. So congratulations on the results. The locking device sales are so strong, and they continue to be. Can you add some color on where that's coming from? And should we expect that to continue for the next, you know, the rest of the year?

Kevin Buchel (EVP and CFO)

I see, that the locking sales are across the board: institutions, schools, high-rises, hospitals, airport upgrades. It's everywhere. The Trilogy line, which is, our original invention, which has been improved over the years, is the number one locking product, electronic locking product in the business. As I, I happen to live in Manhattan, I go to LaGuardia Airport, upgraded with Trilogies, Kennedy Airport, Trilogies, NYU Hospital, Trilogies, department stores, Trilogies. It's a very, very, key product for security in all kinds of buildings, so we would expect this to continue. We also make it in different versions. We make remote control wireless Trilogies that generate recurring revenue. We make standalone Trilogies.

We make Trilogies for schools, so we have a very, very wide range of applications for this lock, and expect the locking business to keep on growing and getting stronger as we add new models to Trilogy. That's how we see it.

Raj Sharma (Senior Analyst)

Great. Thank you. And then, the alarm sales slowdown, we're hearing that that should reverse in a quarter or two. So this slowdown is due to dealer inventories, not due to end-market demand. Is that the correct way to understand that?

Kevin Buchel (EVP and CFO)

Very much so, Raj. That's how we see it. Look at... There's a couple of stats that I pointed out in our prepared remarks, one of which was the run rate. The run rate, we're used to the run rate growing, used to grow by about $1 million a month, or be, would be up $3 million for a quarter.

Raj Sharma (Senior Analyst)

That's the recurring revenue, right?

Kevin Buchel (EVP and CFO)

A recurring revenue run rate.

Raj Sharma (Senior Analyst)

Right.

Kevin Buchel (EVP and CFO)

And then what we saw last quarter, it went from $63 million-$67 million. It went up, went up by $4 million. That was very encouraging, more than $1 million per month. This quarter, it went from $67 million-$72.5 million, almost $73 million. Not quite there, $72.5 million. That's almost a $2 million a month increase. That run rate is telling you that there's a lot of radios being activated, and those radios that are being activated, we're getting paid on them, and those are, those are very good signs. So that's why we believe, if that plus our activation stats, that's why we believe the slowdown that we keep talking about is more of an inventory and distribution issue as opposed to a demand issue.

Raj Sharma (Senior Analyst)

... Great. So, so this alarm slowdown then shouldn't impact the recurring revenues down the street, down, down, you know, a few quarters down, they should pick it up as you see a pickup in alarm sales?

Kevin Buchel (EVP and CFO)

That's what we believe. And remember, you know, the higher the number goes, and it's recurring, it's 41% of overall sales. Remember when, you know, you've been with us long enough to remember it was a very small percent. Now it's 41%. The higher that number goes, the harder it is to keep that increased percentage up. Just simple math. But we've managed to do a good job keeping it up, but we're also introducing new stuff, new products like Prima, to give us more recurring so that we can keep the pace up as we go forward and head to our 2026 goal. The 2026 goal, we didn't even include Prima, so we're giving ourselves extra ways to get there, Prima being one of them.

Also in our 2026 goal, we used 80% gross margin on the recurring, and we were at 90% this quarter. So these are things to keep in mind as we head towards that 2026 timeframe.

Raj Sharma (Senior Analyst)

Got it. Great. Thank you for answering my questions. I'll take it offline. Thank you.

Kevin Buchel (EVP and CFO)

Thank you.

Raj Sharma (Senior Analyst)

Congratulations again.

Kevin Buchel (EVP and CFO)

Thank you.

Operator (participant)

As a reminder, if you would like to ask a question, please press star one on your phone now. At this time, there appears to be no further questions. I'd like to turn the call back over to Mr. Soloway for closing remarks.

Richard Soloway (President and CEO)

Thank you, everyone, for participating in today's conference call. As always, should you have any further questions, 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 Q2 results. Bye-bye. Have a wonderful day.

Operator (participant)

This concludes today's conference call. Thank you for attending.